JIM LEHRER: Ray Suarez has our Fed story.
RAY SUAREZ: While most attention in Washington today was focused on the way taxpayers’ money had already been spent, the Federal Reserve committed itself to big new spending.
The Fed’s Board of Governors announced they would pump more than $1 trillion additional dollars into the economy, including $750 billion to purchase mortgage-backed securities and as much as $300 billion in long-term government bonds.
To help explain what’s behind the latest decisions, we’re joined again by Greg Ip, U.S. economics editor for the Economist.
And one Wall Street trader today, Greg, right after the move, said, “Well, they found out incrementalism didn’t work. Now they’re trying shock and awe.” Is this that big a move on the part of the Fed?
GREG IP, The Economist: It’s a very big move. And, yes, it is shock and awe. Now, the only thing that tempers my enthusiasm a little bit is that this is at least the third round of shock and awe we’ve had from this Fed since this crisis began in 2007.
And what that tells you is that they’ve had to basically step up the intensity of their tactics because of the growing depth of the recession and how serious the problems are out there.
RAY SUAREZ: So it’s broken into two parts, one, buying mortgage-backed securities.
GREG IP: Yes.
RAY SUAREZ: The other, buying Treasury securities. What’s the difference between those two pieces? And what do they do?
GREG IP: OK, well, I’ll step back a little bit. Traditionally, the Federal Reserve will influence the economy by raising or lowering the very short-term interest rate. But in December, that rate basically fell to zero, so they are out of conventional ammunition.
So they said, well, how else can we stimulate the economy? Perhaps we can improve the supply of credit. There’s a lot of people who can’t get mortgages, so purchasing mortgage-backed securities helps on that front.
The other thing that happens is that, when they buy long-term mortgage-backed securities, it lowers mortgage rates, more people can qualify for mortgages, might be willing to buy homes, and buying Treasuries does the same thing. When you buy a lot of Treasury bonds, the price goes up and the rate on the bonds goes down. That lowers long-term borrowing costs for everybody.
Fed buys Treasury bonds
RAY SUAREZ: Help us understand what it means for the Fed to buy Treasury bonds. Isn't that like putting your hand in your left pocket and just shifting the money to your right pocket?
GREG IP: Well, step back a second and ask, what is a Treasury bond? It's essentially one of the ways that the government finances itself. When they want to provide us with services, whether it's Social Security checks or funding the Department of Defense, they can either raise taxes, they can borrow the money from households or from foreign investors, or they can ask the Fed to print it.
And when the Fed purchases bonds from the Treasury, they are basically printing money. They say, "We'll take that bond," and, hey, presto, we will create this money in an account for the government to spend.
RAY SUAREZ: So the Fed creates the money and then just lends it to the Treasury?
GREG IP: That's exactly what happens, and the Treasury goes out, and they spend the money. Now, in this case, they did not directly give the money to the Treasury. They actually will purchase the bonds on the open market. They will purchase them from people who previously bought them from the Treasury, but it is, essentially, printing money.
Risks to the Federal Reserve
RAY SUAREZ: Paul Solman tried to explain all this last night, how money gets created, but is the Fed, in this instance, working as sort of an independent agency, rather than as an arm of our own federal government?
GREG IP: So far, yes. This was an action that was entirely initiated and decided upon by the Fed's own policymaking body, which has a high degree of independence from the government. As far as we know, there was no pressure or any role by the government asking the Fed to do this.
And, indeed, there are two risks to the Federal Reserve in this action. The first is that they could, if they do too much -- they could create inflation, essentially, by printing so much money that it gets spent and it begins to exceed the ability of the economy to provide goods and services. Then you have too much money chasing not enough goods and service. That creates inflation.
I think we're a long way from there right now. The unemployment rate is very high. There is a lot of unused capacity.
The second risk is to the Fed's political independence. Essentially, when they are buying bonds, they might start to worry, are we just becoming an arm of the government? Will there be pressure on us to keep doing this because politicians don't have the courage to raise taxes or borrow the money via going into the public markets?
But I think that that, too, is not a risk that we should worry about too much right now. Essentially, the Fed has decided that those risks are for another day. Right now, the risk is the economy is in a deep recession. There's some risk of actual deflation, never mind inflation, and they have to basically do, in their words, anything in their power to help the economy.
Effects already noticeable
RAY SUAREZ: But by essentially creating a trillion dollars, if you hold dollar-denominated assets in the United States or anywhere else in the world, are they worth just a little less today because there are now so many more dollars around, as of this afternoon?
GREG IP: Not necessarily, because it actually happens -- it depends on what happens to the dollars that the Fed has created. For example, if they print money or create money, it can end up either as currency in your pocket or as money in bank deposits.
But if you don't actually go out and spend that money, it doesn't create any additional demand, it doesn't circulate through the economy, and the total size of the economy doesn't actually grow, so you don't actually end up with a lot more dollars in circulation. That's just another fancy way of saying you don't get a lot of inflation.
Moreover, in the short term, what the Fed has done is, by buying Treasury bonds, it has actually driven long-term interest rates down, and that's actually good for other assets, which actually look more attractive because, you know, the alternative returns are not so good.
RAY SUAREZ: Well, you mentioned the last couple rounds of shock and awe didn't work. Will we know whether this is the jump that will work soon?
GREG IP: It's already helping. I mean, today we saw long-term interest rates fall very sharply. Mortgage rates are down. More people will be able to refinance, but it's not enough. People sometimes can't qualify for mortgages. There's a lot of effort needed still by the Barack Obama administration, for example, on bank capitalization.
RAY SUAREZ: Greg Ip, thanks a lot.
GREG IP: Thank you, Ray.