Crikey

It was one of the most dramatic moments so far in the current financial crisis: in a brief 45 minutes or so of regular trading and then furious after the bell dealings, US shares jumped, market interest rates plunged, the US dollar fell out of bed, the Aussie currency jumped sharply, gold soared, copper bounced and oil picked up… all because of these words from the Federal Reserve in its post-meeting statement at 5.15am this morning, Sydney time:

To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion.

Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

Sound boring, doesn’t it? But, after months of talking about and dabbling a bit at the edges, the Fed has plunged headlong into the most dramatic change in monetary policy the US has seen for decades.

It adopted a policy of “quantitative easing”: virtually printing money because interest rates are so low as to be no longer effective in stimulating the economy.

It revealed plans to buy $US300 billion of US Government debt, a move that was completely unexpected (although an argument was said to be on the cards on the issue at the Fed meeting that ended early today). The Fed also revealed plans to double its purchases of US Government agency debt, especially home mortgage-linked securities: up to $US1.45 trillion worth.

Quantitative easing is a phrase much beloved of bankers, economists and others in the theoretical: it was tried unsuccessful in Japan in the 1990s, the UK started its version a month ago and the Swiss Central Bank is also doing it (and has cut rates). Now the Fed has surprised everyone with its proposals.

But the UK move seems to have been successful and some commentators claimed the Bank of England’s move, which has led to some pressure on market and business rates may have helped settle the argument in the Fed on the issue. The Bank of Japan also said yesterday that it was increasing its purchases of Japanese government debt by about a third to 1.800 billion yen a month. It’s not a lot of money compared with what the UK central Bank is doing: on an equivalent basis, the Fed would have to buy around $US900 billion of US treasuries, but it is an enormous step.

The net effect of these moves is to grow the Fed’s own balance sheet by an extra $US1.15 trillion.

The trick will now be to get the “zombie” and other banks in the US to lend this money at lower interest rates; a big ask when the economy is worsening (the Fed’s observation this morning) and unemployment is still rising.

The Fed’s move is risky for that reason and that’s where the move can come unstuck, but it decided to have a go, with stunning effect.

And while the quantitative easing took the spotlight, the reasons for the move was contained in the Fed’s own statement in these comments about the US economy. They were gloomy, probably the gloomiest the Fed has written for some time.

Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract. Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending.

Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. U.S. exports have slumped as a number of major trading partners have also fallen into recession. Although the near-term economic outlook is weak, the Committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth.

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.