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By Jason Stipp and Jeremy Glaser | 09-13-2012 02:00 PM

3 Key Points in the Fed's Next Stimulus Plan

The Fed's latest action is distinct from earlier measures in a few important ways, but it's still no silver bullet, says Morningstar's Jeremy Glaser.

Jason Stipp: I'm Jason Stipp for Morningstar.

We got the details on Fed Chairman Ben Bernanke's plan for additional monetary stimulus, so-called QE3, on Thursday. Here to offer three compelling takeaways from that report is Jeremy Glaser, our markets editor.

Thanks for joining me, Jeremy.

Jeremy Glaser: You're welcome, Jason.

Stipp: Three things that you plucked out of this report as being especially notable. The first one has to do with how the plan is more open-ended, it's not going to have necessarily an end. How much of the departure is this from the past QE programs that they've run?

Glaser: This is a big change for the Fed. In previous programs, they said, look, we're going to buy $600 billion, $700 billion worth of bonds, and then once we've exhausted that, that's it, and we're going to hope that that stimulates the economy, and if it doesn't, we'll take a look at it later.

This program, on the other hand, as you said, is open ended. They're going to spend $40 billion a month buying mortgage-backed securities, and they're going to keep doing that until employment, in particular, starts to look a lot stronger and starts to look like it's at a more normalized level.

This really means that not only is the amount of this program important, but also the fact that it's communicating to the market, it's communicating to investors, that the Fed is going to continue to be there, they're going to continue to support with easy monetary policy, almost no matter what, until the economy starts to look much, much better or inflation really starts to look like it's going to be a major problem. That's certainly a departure, and it certainly will be interesting to see if people really believe the Fed, how credible this claim is, and how long they’ll really be able to keep this up before they start to feel the pressure to pull back, even potentially if employment doesn't quite get back to that full level.

Stipp: The second notable takeaway, Jeremy, has to do with the Fed's objectives, now in QE1 and QE2, they were looking broadly at trying to stimulate growth. You said that after this report, it's seems like they are much more focused on a particular objective? What's the detail there?

Glaser: They're laser-focused on employment right now. The Fed has a dual mandate: On one hand, they need to keep inflation under control, on the other hand, they need to keep the economy at a sustainable, full employment level. Certainly employment is where they are looking right now. And that makes sense. Employment, I think, has been one of the big disappointments of the recovery so far; the jobs picture hasn’t markedly improved, and I think certainly you could see why that's an area of concern for them.

So the way they structured this program, I think, really helps employment in a few ways, or could help employment in the few ways. By buying mortgage-backed securities instead of Treasuries, they're really trying to keep mortgage rates incredibly low. They are hoping that's going to stimulate the housing industry, and housing is probably one area that could absorb a lot more jobs, it could create a lot more jobs. A ton were lost there during the housing bust and certainly that could help get those numbers to look a little bit more normalized, if they could get people back to work in housing.

So, I think on one side you see how they're working with employment there, and on the other, part of that open-ended mandate is that they're not going to stop until employment gets better. That's really what they're looking at when they decide exactly when these purchases are going to end. So, I think that between those two things, it's pretty clear that [employment is] really in their crosshairs right now.

Stipp: Our director of economic analysis Bob Johnson has also mentioned that housing is not a particularly efficient area of the market, so if we do see demand pick up there it could, as you say, absorb a lot of jobs or create a lot of jobs.

The last one, Jeremy, you mentioned the Fed's dual mandate has to do with the employment side, but also the inflation side, and that has to do with interest rates. What is the takeaway about what the Fed is thinking about interest rates right now. Given that they are doing this extra stimulus, I assume they're not too worried about inflation, but what's the notable takeaway there on that mandate?

Glaser: They don't look to be worried about inflation at all right now. It's not something that they see as imminent to see this huge rise in inflation. They still think that they can exit out of these programs in a graceful way to keep price levels from rapidly, rapidly rising, and I think they're really committed to keeping those rates low for quite some time.

Now, certainly it's easier to say you have a great exit strategy than it is to actually execute a great exit strategy. I think one of the most interesting questions as we go into the next two or three years, if we do see those employment numbers get a lot better, how exactly the Fed pulls themselves out of this, and how they retract really the incredible expansion of their balance sheet over the last few years into a more normal level and keep price levels from really moving very, very rapidly up. I know it's a big concern for investors, and I think it's certainly one that the Fed is going to have to be very strong on when they decided to exit from these strategies.

Stipp: So you mentioned that the Fed is going to do this until it starts to work, but my question to you is, will it work and can this program by itself actually get us where we need to go as far as the employment growth that we want to see?

Glaser: The Fed can't do all the heavy lifting themselves. I think that they've structured this program in a way that can increase its effectiveness. I think they've really thought about the problem they want to solve, unemployment. How they are going to solve it, through the housing market. I think certainly they're trying to target it, but it's still a blunt instrument, and you still have a lot of other worries out there. You have the fiscal cliff that's coming in January that Congress needs to solve. I think there's been a lot of progress in Europe, but certainly there's still a potential of a shock from Europe. Emerging markets, the growth there could be slowing--we don't really know--but certainly that could be a shock that could hurt the United States economy.

Just this program alone is not going to magically take us back to a 4% unemployment rate and we're going to see everything look great. Is it a step in that direction? I think it is. Does it create some room for other policymakers and for businesses to really start to make even more strides toward recovery? Absolutely. But it certainly can't do it on its own.

Stipp: Well, it sounds like some distinctive action by the Fed, some bold action by the Fed. Still a lot of question marks. Thanks for helping us parse that announcement today.

Glaser: You're welcome, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.

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