Dramatic pre-election action from an activist Fed

The Federal Reserve is looking increasingly desperate as it layers one monetary stimulus program on top of another, but no one can fault Chairman Ben Bernanke and company for being timid.

Going into its Sept. 12-13 meeting, the Fed's policymaking Federal Open Market Committee (FOMC) already had renewed its Maturity Extension Program or "Operation Twist," and the New York Federal Reserve Bank was in the process of buying $267 billion in longer-term Treasury securities through year's end.

Now, the FOMC announced Thursday, the Fed also will buy $40 billion per month of agency mortgage-backed securities (MBS) in a third round of quantitative easing (QE3) — until further notice.

Unlike Operation Twist, whose bond purchases are financed by sales of shorter-term securities in the Fed's portfolio, this third round of large-scaled asset purchases will create new reserves and further expand the Fed's already bloated $2.8 trillion balance sheet. And that's not all. The two-fisted FOMC also is having another go at verbal easing.

The FOMC further delayed the expected date of initial short-term rate hikes until at least mid-2015. Since January it had been saying it expected the Federal Funds rate to stay near zero "at least through late-2014." Prior to that, dating back to August 2011, the FOMC was putting the funds rate "lift-off" date at "at least through mid-2013."

Just as important as the actions themselves are the FOMC's new strategy and new way of communicating. There were two important new approaches.

First l, the FOMC made QE3 open-ended. In contrast to QE1 and QE2, in which large amounts of total intended bond purchases were preannounced over a predetermined time period, QE3 has no fixed amount or end date.

The Fed will continue to buy $40 billion of MBS per month indefinitely. "If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability," the FOMC statement said.

This will give the Fed additional flexibility. As Bernanke said in his post-FOMC news conference, how much bond buying the Fed does will be "a function of how the economy evolves," he said. "If the economy is weaker, we'll do more. And in those cases probably rates would be pretty low in any case because the economy is looking weak."

He also made clear that the FOMC could adjust the composition, not just the size of its asset purchases from meeting to meeting.

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