U.S. Fed to spend $40B on bonds, monthly, to boost economy

Federal Reserve Chairman Ben Bernanke speaks during a news conference in Washington, Thursday, Sept. 13, 2012. (AP / Manuel Balce Ceneta)

The Federal Reserve announced bold, open-ended steps Thursday to stimulate the U.S. economy and reduce high unemployment, saying it will spend $40 billion a month to buy mortgage-backed securities for long as necessary.

The Dow Jones industrial average shot up more than 200 points in response, reaching its highest point since the start of the Great Recession. It ended the day at 13,540.

The central bank also extended a plan to keep short-term interest rates at record lows -- close to zero -- through mid-2015, or six months longer than it had planned. And it said it's ready to take other steps even after the economy improves under a "highly accommodative stance of monetary policy."

"The idea is to quicken the recovery," Chairman Ben Bernanke later told a news conference. But he made clear he thinks the economy will need the Fed's intervention even after the recovery strengthens, saying the country's employment situation "remains a grave concern." A new Fed forecast said it thinks unemployment, now at 8.1 per cent, won't fall below 8 per cent this year.

Thursday's actions pointed to how sluggish the U.S. economy remains more than three years after the Great Recession ended. The Fed's policy committee announced the aggressive actions after a two-day meeting.

With less than eight weeks left until the presidential election, the economy is the top issue on most voters' minds. A spokeswoman for Mitt Romney's presidential campaign said the Fed's latest efforts to boost the economy are "further confirmation that President Obama's policies have not worked."

Asked whether the Fed considered the impact of its actions on the election, Bernanke said: "We make our decisions based entirely on the state of the economy ... We just don't take those factors into account."

Bernanke said the Fed does not have a specific economic target for its new stimulus program. "We are looking for ongoing sustained improvement in the labour market," he said. "There's not a specific number in mind. But what we've seen in the last six months isn't it."

The Fed also lowered its outlook, saying it now expects growth to be no stronger than 2 per cent this year. That's down from its forecast of 2.4 per cent in June. But it expects growth to accelerate next year to as much as 3 per cent.

The Fed's actions come a week after the European Central Bank announced its most ambitious plan yet to ease Europe's financial crisis by buying unlimited amounts of government bonds to help countries manage their debts.

The bond purchases announced Thursday are intended to lower long-term interest rates to spur borrowing and spending. But some economists said they thought the benefit to the economy would be slight.

"We doubt it will be enough to get the economy on the right track," said Paul Ashworth, an economist at Capital Economics. "It's only a matter of time before speculation begins as to when the Fed will raise its purchases from $40 billion a month."

The Fed's new bond purchases, which will start Friday, amount to less per month than either of its first two bond purchasing programs. But by committing to buying bonds indefinitely, the Fed is seeking to assure investors and consumers that borrowing will remain cheap far into the future.

"In many ways, today's actions represent the beginning of a new phase in Bernanke's efforts to get the economy moving again," said Michael Feroli, an economist at JPMorgan Chase Bank.

The announcement marked the Fed's latest dramatic intervention since the financial crisis erupted in 2008 and the Great Recession shot unemployment into double digits. The Fed cut its benchmark short-term rate to near zero and has kept it there for nearly four years. It's also bought more than $2 trillion in Treasurys and mortgage bonds to try to drive down long-term rates.

Investors had been expecting this latest action from the Fed after Bernanke said in a speech last month that persistently weak hiring remains "a grave concern" that inflicts "enormous suffering."

The Fed has been under pressure to act because the economy is still growing too slowly to reduce high unemployment. The unemployment rate has topped 8 per cent every month since the Great Recession officially ended.

"If the outlook for the labour market does not improve substantially, the committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability," the Fed's policy committee said in a statement released after the meeting.

The Fed also expressed concern about overseas markets but did not mention Europe or China, two regions that help drive the global economy but are struggling. "Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook," the statement said.

The statement was approved on an 11-1 vote. The lone dissenter was Richmond Fed President Jeffrey Lacker, who worries about igniting inflation.

Bernanke sought to lower expectations about how much the Fed's intervention might help.

"We're just trying to get the economy moving in the right direction, to make sure that we don't stagnate at high levels of unemployment," he told the news conference. "All that being said, monetary policy, as I've said many times, is not a panacea."

Skeptics warned that further bond buying might provide little benefit. Rates are already near record lows. Critics also warn that more bond purchases raise the risk of higher inflation later.

Still, some economists suggested that the Fed might continue to buy $40 billion a month in mortgage bonds for up to three years. That's how long some analysts expect it will take for the unemployment rate to dip below 7 per cent, toward a "normal" rate of 6 per cent or less. The rate is now 8.1 per cent.

If the new bond buying lasts three years, Ashworth said it would add about $1.4 trillion to the Fed's purchases. That would be close to the $1.7 trillion the Fed spent in its first round of bond buying. That began in November 2008, at the height of the financial crisis, and ran until March 2010.

The Fed's second bond-buying program totalled $600 billion. It ran from November 2010 through June 2011.