The Federal Reserve Open Market Committee announced open-ended quantitative easing today, including outright bond purchases with invented money. Eschewing the mid-2015 deadline for the $85 billion a month purchases of Treasuries and mortgage-backed securities, Fed Chairman Ben Bernanke announced that the purchases will continues indefinitely, until unemployment reaches 6.5%, as long as inflation remains at 2.5% or under.
This is implementation of the so-called “Evans Rule,” advocated by Chicago Fed head Charles Evans. Evans’ position is that setting chronological deadlines that keep being extended keeps the markets unsettled. Telling the markets that QE would continue until certain thresholds were reached will give industry the confidence to make long range plans, according to Evans.
However, combined with the expected acceleration of QE by Japan and national bailouts by the European Central Bank, hundreds of billions of dollars worth of currency are being pumped into the system each month with no end in sight. Some analysts believe that the central banks will be unable to counter a sudden increase in inflation before it gets out of hand in this age of computer-driven trading that occurs in a fraction of a second. If a sudden, substantial rise in interest rates occurs, it could cripple the ability of many governments to meet the payments on their accumulated debts, leading to currency devaluation and defaults.
This brings forward the question about the Fed’s new policy- can the Fed bring unemployment down to 6.5% before inflation ignites? I’m afraid that we will all learn that answer together.