QE3 and the Economy

 

Fed’s Evans Says QE3 Will Make Economy More Resilient

By Joshua Zumbrun and Mark Clothier - Sep 18, 2012

Federal Reserve Bank of Chicago President Charles Evans said the central bank’s third round of quantitative easing will help the economy keep growing despite headwinds from Europe’s debt crisis as well as potential U.S. tax increases and spending cuts.
“Given the slow and fragile recovery, the large resource gaps that still exist, and the large risks we face, it remains clear that we needed a more resilient economy,” Evans said today according to prepared text of a speech in Ann Arbor, Michigan. The Fed’s actions last week “provided a more accommodative monetary policy that can help us achieve such resilience.”
Evans has been among the most outspoken advocates for additional monetary stimulus from the Fed in the past year. In an Aug. 27 speech he called for the Federal Open Market Committee to engage in open-ended asset purchases, a strategy that was adopted by the Fed in its Sept. 13 decision to purchase $40 billion a month in mortgage debt until the labor market improves.
“We’re going to look at the labor market and the way the economy is going and also inflation pressures, and if it seems like we need to continue to do this, we’ll continue to do this next year,” Evans said in response to audience questions.

Operation Twist

The central bank will have to consider continuing the mortgage-debt purchases into 2013 and should purchase additional Treasuries once the central bank’s Operation Twist program expires in December, Evans said.
The Fed maintained Operation Twist, selling about $45 billion of short-term Treasury securities a month and buying about $45 billion of longer-term Treasuries, even as it began purchasing $40 billion a month of mortgage-backed securities.
Evans told reporters after the speech that a pace of $85 billion in mortgage-backed securities and Treasury securities may be appropriate into 2013.
“We’re looking for stronger employment growth, some beginning declines in the unemployment rate and stronger growth,” Evans said. “I’d be surprised if we would see enough evidence of that by the end of this year. So under that conditioning, I would expect that we would continue at something like an $85 billion pace of purchases post December.”
The Chicago Fed chief renewed his call for the policy makers to provide accommodation as long as unemployment remains above 7 percent and the inflation outlook is under 3 percent. Evans said that although the Fed did not adopt this policy last week he supports the QE3 decision “wholeheartedly.”

Disappointing Growth

Evans said the Fed’s actions will help strengthen a pace of growth that has been “disappointing” and help counteract “greater downside risks posed by the slowdown in global economic growth, the economic turmoil in Europe and the fast- approaching U.S. fiscal cliff.” If Congress doesn’t act, more than $600 billion in automatic tax increases and spending cuts will take effect starting in January.
Evans raised his growth and inflation forecasts in response to the Fed’s new program and now sees the unemployment rate falling faster, the policy maker told reporters.
“My own projections did have somewhat stronger growth because of that,” Evans said. “If I’m looking for -- as one benchmark -- seeing the unemployment rate fall below 7 percent, I think it will happen much sooner than if we had not undertaken that action.”

‘Heroic Forecast’

Evans said unemployment could fall below 7 percent by the end of 2014.
“I don’t think that’s a heroic forecast,” he said.
The FOMC took action last week following a Sept. 7 Labor Department report showing the economy added 96,000 jobs in August. The unemployment rate dropped to 8.1 percent from 8.3 percent as 368,000 people left the labor force.
Evans said that the central bank’s policy has been unable to have its full effect on the economy because not all mortgage holders have been able to refinance.
“We’ve been fighting against a variety of issues that are clogging the effectiveness of the monetary policy transmission channel,” Evans said in response to audience questions. “Normally it’s the case that when you have such a large amount of monetary stimulus in place we would have seen an enormous refinancing wave of mortgages.”

Underwater Borrowers

Yet many borrowers who are underwater, or owe more on their mortgage than the value of their home, are unable to refinance and “if there were adjustments made in those refinancing programs we could deliver much more effectiveness of our policy accommodation,” he said.
In addition to undertaking QE3, the Fed said last week that economic conditions would likely warrant holding their target interest rate near zero through at least mid-2015, extending a previous date of late 2014. The Fed said low interest rates will remain appropriate for a “considerable time” after growth strengthens.
The Fed is contending with a slowing economy. Gross domestic product climbed by 1.7 percent in the second quarter, down from 2 percent in the first quarter and 4.1 percent in the fourth quarter of last year.

Highly Accommodative

“Stating that we expect to keep a highly accommodative stance for policy for a considerable time after the recovery strengthens is an important reassurance to households and businesses that Fed policy will not tighten prematurely,” Evans said.
Stocks and commodities have rallied since the Fed said on Aug. 1 that it would “provide additional accommodation as needed to promote a stronger economic recovery,” foreshadowing the launch of QE3 last week.
The Standard & Poor’s 500 (SPX) Index rose 6.3 percent from Aug. 1 to yesterday. The S&P GSCI index of 24 commodities has risen 6.4 percent in that time period.
Evans said the Fed should be willing to risk a little more inflation in order to help improve the labor market. The Fed should “not be resistant” to policies that lower unemployment closer to its longer-run level “but run the risk of inflation running only a few tenths above our 2 percent goal.”
Evans, 54, became president of the Chicago Fed in 2007 after serving as the bank’s director of research. Fed presidents rotate voting on monetary policy with Evans voting next year.