The Federal Reserve accomplished two things yesterday, one expected and another that changed their entire decision-making process. The expected part was replacing the balance sheet neutral Operation Twist with a plan to purchase an additional $45 billion in long-term treasury securities while ceasing to sell short-term notes to fund the purchases.
In other words, the Fed is going to keep buying things as before but will now be using borrowed money. The program will add $1 trillion to the Fed's balance sheet in 12 months.
The stunner was Bernanke putting an explicit goal on unemployment of 6.5%. While the Fed has always given numerical inflation targets, employment goals were left fuzzy. Not anymore. As long as unemployment is greater than 6.5%, Wall Street can assume stimulus will stay in place or pick up steam.
"Previously they were giving us a date, they said they anticipated rates would stay low through mid-2015. What they wanted to do now was to frame it not so much as a specific date, but to put it in terms of economic indicators," explains Michelle Girard, senior economist at RBS, in the attached clip. As a result the market gets more information as to what the Fed is looking at and what they want to achieve.
Goal setting is important whether you're trying to lose weight or trying to create jobs for the roughly 1.5 million people who need to find them in order to get us to 6.5% unemployment. The rub in this case is the nature of the numbers. Unemployment and inflation data are notoriously difficult to measure accurately. Using them as the basis of trillion dollar decisions is questionable, to be polite.
Girard says the Fed has assuaged concerns about the quality of the data by leaving themselves "a lot of wiggle room" in terms of policy trigger points. "In his press conference Bernanke was very clear that they are going to look at a host of indicators", leaving them with the ability to modify their strategy as the situation warrants.
The goals are an improvement, but what about the method?
Economists are split on the impact of the more than $2 trillion expansion of the Fed's balance sheet over the last four years. To liberals, the Fed didn't spend enough. Conservatives think the entire idea of throwing money at the economy is flawed from the start. Almost no one thinks what's been done so far worked.
"I don't think that this is going to do much for the economy," concludes Girard with a resigned grin. "But if the Fed believes that the economy needs more support, then expanding the balance sheet is the thing that they have control over and that's what they should be doing."