As expected, the Federal Reserve announced this week plans to purchase more long-term bonds from the public. The so-called QE II is under way.
In addition to keeping bank interest rates near zero, the Fed announced this week that principal from previous bond purchases (Quantitative Easing I) will be reinvested and $600 billion of new, “longer-term” Treasury securities will be bought by next June.
Fed monetary policy actions like these are conducted at the Federal Reserve Bank of New York. The New York Fed said there will be roughly $110 billion per month ($75 billion of new money and $35 billion from reinvestment) over the next eight months.
However, the Fed doesn’t want to take on too much risk. The bulk of this money is being used to purchase Treasuries of short or medium maturity, rather than what the market normally considers long-term bonds. Only 6 percent is planned for purchases of Treasuries with maturity dates of 10 years or longer.
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Richard Barley of The Wall Street Journal had said at the start of this week that if QE2 “either disappoints because the scale is too small, or works too well in raising inflation expectations, Treasury yields will rise and corporate bonds will suffer too.” That’s just what happened immediately after the announcement.
On Wednesday afternoon, the 10-year and 30-year Treasury bonds fell in price, raising their yields, while shorter-maturity Treasuries were unchanged. These same long-term bonds often serve as benchmarks for many consumer loans, like mortgages and car loans. The rising interest rate on long-term Treasuries is likely to raise consumer borrowing rates.
The new policy announcement also had a negative impact on the value of the dollar. The dollar fell against all major currencies except the yen.
The higher consumer rates won’t help Idaho consumers, but a lower-value dollar could help some Idaho companies. If the dollar remains low, export pricing will be more competitive.
According to the Idaho Department of Commerce, Idaho companies had $3.88 billion in export sales to more than 140 countries during 2009. For example, Idaho firms sold arms and ammunition valued at $1.7 million to France. More than $4.9 million worth of vegetables were sold in Hungary, and more than $600,000 worth of organic chemicals were shipped to Kazakhstan.
A declining dollar could continue to boost Idaho exports. But there is no free lunch.
By raising inflation expectations, the long–run effect of the $600 billion in new purchases is more likely negative. For this reason. many policymakers are leery of the plan.
The vote for this new monetary policy was not unanimous. Thomas M. Hoenig, president of the Federal Reserve Bank of Kansas City, has long opposed the excessively loose monetary policy currently in place and voted against the move. Mr. Hoenig has gone as far to say that this quantitative easing is a “bargain with the devil.”
Presidents from other regional Fed banks, such as Charles Plosser of Philadelphia, Richard Fisher of Dallas and Jeffrey Lacker of Richmond, have also come out in opposition to more bond buying. These gentlemen, however, are not currently voting members of the Fed’s monetary policy making committee. Plosser and Fisher will have a vote throughout 2011.
The financial market reactions to the new program are long-term negative, and new policymakers are on their way. The economy may get a short-term boost from the additional $600 billion, but next year we are all in for a surprise.
Peter R. Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.