QE2 To Be Gradual As Opposed To “Shock And Awe”

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The Federal Reserve is close to embarking on another round of monetary stimulus next week, against the backdrop of a weak economy and low inflation—and despite doubts about the wisdom and efficacy of the policy among economists and some of the Fed’s own decision makers.

The central bank is likely to unveil a program of U.S. Treasury bond purchases worth a few hundred billion dollars over several months, a measured approach in contrast to purchases of nearly $2 trillion it unveiled during the financial crisis.  The announcement is expected to be made at the conclusion of a two-day meeting of its policy-making committee next Wednesday.

The Fed’s aim is to drive up the prices of long-term bonds, which in turn would push down long-term interest rates.  It hopes that would spur more investment and spending and liven up the recovery.  But officials want to avoid the “shock and awe” style used during the crisis in favor of an approach that allows them to adjust their policy, and possibly add to their purchases, over time as the recovery unfolds.

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Though details remain to be being sorted out internally, the broad outlines have taken shape.

Unlike in March 2009, when the Fed laid out a program to buy $1.75 trillion worth of Treasury and mortgage bonds over six to nine months, officials this time want flexibility as they assess if the program is working.

Mr. Bernanke has used the analogy of a golfer with a new putter: Unsure how it will work, he finds best strategy is to tap lightly at first and keep tapping until the golfer figures out how best to use the putter.

The Fed could leave open the possibility of more purchases in the future, particularly if inflation is projected to remain below 2% and the unemployment outlook remains high, which is currently the expectation of many officials.  Or it could halt the program if the economy or inflation surprisingly take off, officials have said.

“Fed Gears Up For Stimulus: Eyes Gradual Bond Buying Of Several Hundred Billion Dollars; Doubts Linger”, Jon Hilsenrath and Jonathan Cheng, The Wall Street Journal, October 27, A1

This article drove the action today including the selloff in stocks, treasuries, gold, oil and other risk assets and the rally in the dollar.

Top Gun forecast just such a gradual approach by the Fed three weeks ago (“QE2: Not What The Market Is Expecting”, Top Gun FP, October 7).

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