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The Fed's latest bet: I'll have another

June 21, 2012

| MoneyRates.com Senior Financial Analyst, CFA

While "I'll Have Another" failed to win the Triple Crown, that didn't stop the Federal Reserve from "having another" this week -- as in another round of Operation Twist.

The Fed's Open Market Committee meeting opened to great expectations, but closed to little more than a shrug. The stock market essentially waffled up and down after the Fed's announcement, as the reality sank it that there is just too much about this economy that the Fed can't change.

More of the same

The Fed's announced that it will continue "Operation Twist," which is a program to bring long-term interest rates down by exchanging short-term Treasuries for long-term ones. This program was due to expire this month, but now the Fed has pledged to buy $267 million in long-term Treasuries over the remainder of the year.

In essence, the Fed continues to operate on the premise that lower interest rates will stimulate the economy -- even though three years of extremely low interest rates have failed to do so. This may not be blind faith on the part of the Fed so much as an acknowledgement that there is really little it can do to pull this economy out of the doldrums.

Changing its forecasts

The Fed also changed its forecasts for economic growth and unemployment, in each case reflecting a more pessimistic outlook for the remainder of this year and beyond. The Fed also lowered its inflation projection.

If it seems that the Fed is avoiding accountability for its forecasts by changing those forecasts as the results become known, remember that you can always compare Fed's original forecasts from the start of the year with the actual economic results by looking at the Fed Reality Check feature on MoneyRates.com.

What the Fed can't change

Though the Fed can change its forecasts, the limitation on its policy responses is that there is just too much about the economy that the Fed can't change. Here are three prominent examples:

  1. Consumers aren't clamoring to borrow. With a slow economy and under a mountain of debt already, consumers aren't really in a position to beat a path to the nearest loan officer. Under these conditions, lowering interest rates has little stimulative effect. It may actually have some negative impacts, such as draining interest income from the economy, and reducing the incentive for lenders to make loans.
  2. Global demand is slipping. With the crisis in Europe and slowdowns in large developing countries affecting U.S. trade, the problem is much bigger than the Fed's jurisdiction.
  3. Uncertainty is reining in businesses. On top of the aforementioned economic problems, congressional gridlock and a closely-contested presidential race are prompting businesses to wait and see rather than make bold moves to expand.

In a way, the Fed changing its forecasts in light of the latest economic figures is a useful reminder of one cold reality: The Fed is forced to follow the economy more than lead it.

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