What people think is going to happen to the economy has a huge influence over what actually happens. If you can change peoples' expectations, you can change the world.
The Federal Reserve knows this. And, as Robert Smith pointed out this morning, Ben Bernanke and the Fed have been using the power of expectations more and more in recent years.
This afternoon, the Fed took another huge step in this direction.
The Fed just released a policy statement that is a very big deal not so much because of the specific actions the Fed announced, but because of the language the Fed used, and the expectations that language will create.
The Fed announced a new plan to buy $40 billion of mortgage bonds every month. It's the third round of quantitative easing — buying long-term bonds to drive down interest rates, which is supposed to encourage people to spend money and get businesses to invest and hire workers. (Here's more on quantitative easing.)
But the purchases themselves aren't what makes today's announcement so important. In fact, $40 billion a month is smaller than previous rounds of quantitative easing.
In earlier rounds, though, the Fed announced at the outset how long the program would last. This time, the Fed says it will keep buying bonds until the job market gets a lot better — and that if that doesn't happen soon, the Fed will take even more action.
That's what makes today's announcement such a big departure from what's come before. Here's the key language from today's statement:
If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability ...
the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens ...
Essentially, the Fed is saying: We are going to do whatever it takes to bring down unemployment (as long as inflation stays low).
The boldness of this statement will change people's expectations about the economy. And that may actually speed up the grindingly slow economic recovery in the real world.
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