10/26/2012 03:08 pm ET

The Federal Reserve Declares Independence

Will open-ended easing work?

Fed Opens Door on New Era

In an unprecedented move, the Federal Reserve voted to expand its balance sheet by $40 billion per month via mortgage-backed securities (MBS) purchases until the labor market improves "substantially."

Chairman Ben Bernanke was especially vague in his description of what "substantial" actually implies, in the press conference that followed the statement; he underscored that the policy is being executed in the context of price stability.

This open-ended approach to easing, contingent on an improvement in the labor market, has never been done. The focus on MBS over Treasury purchases allows the Fed to better target support for the housing market, a critical job creator. The bang for the dollar in boosting a sector that is already improving is much greater than just lowering Treasury yields, which are close to record lows.

Moreover, the Fed also extended its forward guidance on holding short-term interest rates near zero to mid-2015 from late 2014. This is designed to provide investors with some assurance that the Fed intends to hold easy monetary policy longer than in the past (e.g., investors will have ample time to reap the returns of riskier and more productive investments).

Read the full article on our Economic Minds blog.