I know, many of you think Ben Bernanke is some crazy Keynesian, Helicopter Ben distributing your dollars on the economy like so much pixie dust.
It's not true.
I am glad I waited until tonight to write this because we needed some distance from the Fed's decision to engage in Operation Twist Part Deux. ("What's Part Une?" you say. There you go.) It was anticipated that the very unusual two-day meeting of the Fed, along with a five-page statement at its end, would be earth shattering.
It was not. It was about as mild a move as you could make given the sizzle Bernanke had sold for weeks starting at Jackson Hole.
In short, the Fed will sell $400 billion of its holdings of short-term Treasury securities -- which by tradition has been 100% of its portfolio -- and will use the proceeds to buy long-term U.S. Treasuries. By doing so it hopes to reduce long-term interest rates which more closely track commercial and mortgage loan rates. If they are successful, homeowners refinance and have extra spending cash, and businesses are induced to invest more by lower borrowing costs.
Operationally, the Fed is going to do this in 8 $50 billion steps between now and June 2012. At $400 billion, this is smaller than QE2 by a third, and as a share of GDP smaller than the original Operation Twist in 1961. The paper linked above estimates that the effect of the original Twist was 0.13-0.16% on 10 year Treasuries. So the real question has to be whether the effect this time wouldn't be 2/3 of that? As I write this near midnight ET the day after, the 10-year Treasury fell 0.14% from the pre-announcement level.
Will it help? Yes, a little. If the Fed does not stop easing here, the next stop would be a 10-year rate at 1.5%, about where we were at the worst of the Great Recession. It might make GDP grow a little more than 2% vs the current expectations of 1.5%, but not much more. That will not be enough to make a big dent in unemployment. That, plus the Fed's statement that the economy was weakening may explain what's happened in markets today. (That and the continuing dithering in Europe over Greece.)
The Fed is hemmed in. It has a dual mandate to promote both price stability and high employment. The Republicans may not like it -- if so, they should change the mandate to just the former, as has happened over the last 20 years in many other countries. (Happens to be my own little corner of geekery.) Let someone drop that bill in the House hopper tomorrow. But even with a more liberal dual mandate, the Fed has three bank presidents who again have stood for more hawkish policy. 'Twas ever thus at the Fed, and I'd just as soon see the GOP Congress leave well enough alone, though I agree with Matt Yglesias that politicians speaking on monetary policy is meet and right so to do. That and the more conservative bank presidents will give you results like yesterday, which I think will turn out better than either conservatives or liberals think.