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Here comes QE3: The Federal Reserve decides to stimulate U.S. economy (video)

Federal Reserve Chairman Ben Bernake. The Fed today decided to undertake another round of quantitative easing to stimulate the U.S. economy.
Federal Reserve Chairman Ben Bernake. The Fed today decided to undertake another round of quantitative easing to stimulate the U.S. economy.

The Federal Reserve's Open Market Committee wrapped up its September meeting and, as expected, it's decided to undertake another round of "quantitative easing" — injecting money into the economy in order to stimulate economic activity and lower the 8.1 percent unemployment rate. The markets took off in response to news, with the Dow up 110 point in early afternoon trading.

This is from the Fed's statement:

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.  The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.  These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative. 

So what does that mean? Well, the Fed decided to focus QE3 in an open-ended manner on mortgage-backed securities. The first round of QE in the throes of the financial crisis involved a similar strategy, while QE2 in 2011 concentrated on U.S. Treasuries. Marketplace's Paddy Hirsch provides an excellent video explanation of what QE is in the video below, using his now-legendary white board.

This will likely benefit California, which is beginning to see some life in its real estate market. The Fed's action, coupled with historically low interest rates and low home prices, will make it easier for people to commit to buying a house, or to refinance an existing mortgage.

The Fed also decided to continue its policy of selling short-term securities and buying longer-term ones — "Operation Twist" — to drive down long-term interest rates. It has to do this because short-term interest rates are already at zero, preventing the Fed from cutting them. In fact, the Fed has said that it will keep them there through 2015.

Finally, the Fed doesn't seem at all worried that putting money into the economy will increase inflation. It currently has a 2-percent target, and that's where the Fed expects it to stay. Inflation has ticked up recently, but that can be blamed on the spike and gas prices that was driven by a shortage in California of the state's special blend of fuel, due to Chevron's Richmond refinery fire last month; and the impact that hurricane Isaac had on the oil production and refining operations in the Gulf.

UPDATE: Felix Salmon rightly notes that the Fed, with QE3 even on a smaller scale than QE1 or QE2, is committing to providing the steady stimulus to the economy that fiscal authorities (you know, Congress) won't.

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