Fed will try to boost economy with more of what it tried twice before. Quantitative Easing #3

Ben Bernanke is going to try it again. In an expected move Thursday, the Federal Reserve has decided the moderate growth of the economy has not done enough to reduce unemployment. It is going to provide additional help in the matter. So today, it announced another round of "quantitative easing," the third such round, so it gets the name, QE3:

In addition to the QE announcement, the bank stated it will maintain its interest rate range of 0 to 1/4 of a percent until mid-2015, a later date than their previous commitment to keep rates low through 2014. Also new is the bank's commitment to keep policy easy even after the recovery has gotten stronger: 'The Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.'

What does this mean?

The Fed is charged with pursuing both price stability and full employment. But the tepid growth of the economy has made the latter difficult, to say the least. Last quarter, gross domestic product only increased at 1.7 percent level. The official level of unemployment is 8.1 percent, although other measures make it much higher.

The Fed goal in the recession and its aftermath has been to reduce the price of credit to get lenders to actually lend. That, theoretically, means the economy will grow faster. One key way to do this has been to lower the band of interest that banks charge when they lend to each other as a means of getting them more interested in lending to businesses that want to get started or expand. In the United States, that band of interest now runs from zero to one-quarter percent, an historic low.  

The problem is that when you drop the interest rate to zero, there is no place else to go if the reduction fails to work or at least doesn't work as much as you want it to.

Instead of taking that no risk money they get and passing it along to businesses in the form of loans with an interest rate of seven or eight or nine percent, they are taking it and buying Treasury bonds that pay maybe two percent interest. The reason? They think the risk of those businesses not paying off the loans is too high. So they make a two percent profit with no risk.

Through quantitative easing, the Fed pumps money into the banks by buying bank assets that aren't performing well, toxic assets. In this case, the Fed will buy mortgage-backed assets. The bank frees itself from these, gets money from the Fed and presumably, the hope is, anyway, lend that money to those businesses that can't get loans.

Meanwhile, the Fed buys Treasury bonds in large quantities. That reduces the yield of the bonds, the interest that a bondholder receives. That forces bankers to look elsewhere for a better return. The Fed hopes that the elsewhere is those businesses that need loans, which then use them to grow their business and hire more workers, reducing the unemployment rate, expanding payrolls and expanding the amount of money workers spend on products that other workers make.

One change from the previous quantitive easing #1 and #2 is that this one will be open-ended. The Fed will keep it up until the economy improves and the official unemployment rate falls at least another percentage point.

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^{Big thanks to Paddy Hirsch at Marketplace.}