QE3 – Yes, it’s political

14th September 2012

The Federal Open Market Committee (FOMC) voted in favour of an asset purchase programme that will see the central bank buy up $40 billion mortgage-backed securities (MBS) a month. Interestingly there is no pre-defined limit for this latest round, with the Fed suggesting it would wait to see an improvement in economic indicators before withdrawing the stimulus.

It did not take long for politicians on both sides of the aisle to respond. Republicans levelled a number of criticisms at Bernanke suggesting his decision was motivated by a desire to help Barack Obama's re-election campaign, while Democrats were clearly pleased by the announcement.

The idea that the Fed chairman is using monetary policy to signal support for the incumbent seems wrong-headed – not least because the he is himself a Republican. However, just because it is not party political does not make the decision to embark on another round of easing apolitical.

Judging by his speech on Thursday the Fed is now shifting its focus from simply supporting the economic recovery – that is, focusing on the price stability aspect of its mandate – to prioritising employment. While this does not favour either the Republicans or Democrats, it sets a new stake in the ground in terms of public policy. If politicians are not able or willing to improve the conditions of the US labour market then the central bank will.

In the words of Mr. Bernanke:

"As you know, the Federal Reserve conducts monetary policy under a dual mandate from Congress to promote maximum employment and price stability. The United States has enjoyed broad price stability since the mid-1990s and continues to do so today. The employment situation, however, remains a grave concern. While the economy appears to be on a path of moderate recovery, it isn't growing fast enough to make significant progress reducing the unemployment rate. Fewer than half of the 8 million jobs lost in the recession have been restored. And, at 8.1 percent, the unemployment rate is nearly unchanged since the beginning of the year and is well above normal levels.

The weak job market should concern every American. High unemployment imposes hardship on millions of people, and it entails a tremendous waste of human skills and talents. Five million Americans have been unemployed for more than six months, and millions more have left the labor force-many of them doubtless because they have given up on finding suitable work. As the skills of the long-term unemployed atrophy and as their connections to the labor market wither, they may find it increasingly difficult to get good jobs, to their and their families' cost, of course, but also to the detriment of our nation's productive potential."

His nod to the numbers of unemployed who have dropped out of the labour force, something that the headline unemployment figures ignore, helps demonstrate the scale of the problem facing the US economy. Continued uncertainty over the prospect of a fiscal cliff has added to the pessimistic outlook and provided a big disincentive for companies to hire in expectation of a pick-up in demand.

Just as the Fed's QE programme initially put potentially unlimited liquidity behind the sovereign, pushing borrowing costs to historic lows, it is now directing its extensive resources at stimulating the labour market. In effect it lays down a challenge to American businesses – we will keep spending until you start hiring:

"[The] Committee will closely monitor incoming information on economic and financial developments in coming months, and if we do not see substantial improvement in the outlook for the labor market, we will continue the MBS purchase program, undertake additional asset purchases, and employ our policy tools as appropriate until we do."

If you take the definition of political as "Of or relating to the government or the public affairs of a country" that sounds plenty political to me.


More on Mindful Money:

Has Bernanke done all he can do to boost growth?

QE3 – The winners and losers

Is Paul Krugman a false idol?

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