JONATHAN COHN AUGUST 11, 2010
As you may have read or heard, the Federal Reserve yesterday sent a clear signal of concern about the economy and took some steps to boost the recovery, such that it is. After a regularly scheduled meeting, the Federal Open Market Committee announced that “the pace of recovery in output and employment has slowed in recent months” and that the recovery was “likely to be more modest in the near term than had been anticipated.” In response, the FOMC decided to "maintain its large balance sheet" by "reinvesting proceeds from maturing mortgage bonds into long-term government bonds."
If, like me, you slept through a few too many classes in introductory economics, you might not understand exactly what that entails--let alone be in a position to judge whether the Fed's action is enough to make a difference in the economy. So I asked Dean Baker, of the Center for Economic and Policy research, to explain it in plain English:
The Fed currently holds somewhere around $1.3 trillion on mortgage backed securities. Every month this number is falling as mortgages are paid off or refinanced and the Fed gets cash in lieu of its bonds.
It could just hold this cash and in effect pull money out of circulation. Or, it could do what it committed itself to yesterday, buy more government bonds.
This prevents the Fed from being contractionary with its policy, but given the sums of money involved (we're probably talking about $150 -$200 billion over the next year), it is not likely to have much of a positive impact in pushing rates lower.
Paul Krugman, who also understands economics and speaks plain English, has a similar take at his blog:
What the FOMC announced was a slight change in policy: rather than allowing its balance sheet to shrink as the mortgage-backed securities it owns mature, it will maintain the balance sheet’s size by reinvesting the proceeds in long-term government bonds. Roughly speaking, it has gone from a completely crazy policy of monetary tightening in the face of massive unemployment and incipient deflation, to a policy of standing pat in the face of same. Whoopee.