Buying Back Debt- What does it mean?

What has the Fed actually announced?


The Federal Reserve will buy $600bn (£373bn) of long-term US government debt, known as Treasuries, by the end of June. This is equivalent to about 4% of the US economy's annual output.

It is in addition to the Fed's previously announced plan to reinvest $250bn-$300bn of repayments it is due to receive on its existing $1.25tn portfolio of US mortgage debt over the coming year.Together, the moves equate to $110bn of Treasury purchases per month.

Why is the Fed doing this?

The US economy has slowed down markedly in recent months.
But the Fed is also worried about falling inflation, which it described as "trending lower".
Consumer prices inflation has fallen below 1%, but other measures suggest inflation has fallen even lower.
In previous speeches, Mr Bernanke made clear that the Fed would not tolerate deflation - or falling prices.
Deflation can become self-perpetuating - as has become the case in Japan in the last 20 years - because consumers may postpone spending decisions in the expectation of cheaper prices.
Falling prices and wages would also make it more difficult for Americans to pay off their debts.

Isn't this what everyone was expecting?

Almost. The markets had expected the headline number to be $500bn.
Markets have been expecting some form of quantitative easing (QE) ever since Mr Bernanke openly discussed the option in a speech to fellow central bankers at Jackson Hole in August.
Even the rough parameters of the policy announcement - that it would be a much smaller than the Fed's preliminary round of QE, worth around $1.75tn - were flagged up a week in advance via the Wall Street Journal.

Why is it so much smaller this time?

During the financial crisis, the Fed took a "shock and awe" approach, with the aim of restoring confidence in a financial system facing total meltdown.
This time, the aim is to help the flagging economy, and there is less of a sense of urgency.
Mr Bernanke has expressed concerns that QE is untested in the US, apart from during the exceptional circumstances of the financial crisis.
So he wants to dripfeed QE into the economy and see what the reaction is before deciding whether to open the spigot more.

This more cautious approach is also needed if Mr Bernanke is to keep the support of more sceptical colleagues on the Fed's policy-setting committee.

What did the markets make of it?

The dollar and US government bond prices were extremely volatile as the announcement was made, as investors put in place last-minute bets.Against the euro, the dollar moved up and down 1% in the space of a minute.
But in the immediate aftermath of the announcement, the dollar, US government bonds and US stocks all remained largely unchanged. This is because the decision was largely guessed by markets in advance.
The dollar has already fallen about 10% against the euro since Mr Bernanke's Jackson Hole speech in August.

How does QE work?
In theory, it should influence the economy through a number of channels:
the Fed buys US government bonds, pushing their price up and long-term interest rates down

banks, flush with cash, lend more of it out

easier and cheaper borrowing encourages companies to invest

investors who sell the bonds to the Fed use their new cash to buy other assets (equities, corporate bonds), which pushes their prices up

higher asset prices make people feel richer, so they spend more

more dollar cash in circulation depresses the dollar's value compared to other currencies, making the US economy more competitive, and raising import prices in dollars.

So what's the controversy?

First of all, it's unclear whether QE will work as intended:
banks may refuse to lend the new cash, because they are still worried about loan losses
companies may refuse to invest - even if they can borrow more cheaply - because consumer spending is so weak
it probably won't stop house prices falling further, and this is the main reason consumers are afraid of spending and banks are afraid of further loan losses.Even advocates such as economist Paul Krugman are pessimistic about its chances of success, although they say it is still worth a shot.

Second, many critics fear longer-term consequences:
it could be too successful, and lead to high inflation
it could create more asset bubbles, which will eventually pop, bringing the financial system down again
it could spark a "currency war", with other central banks trying to devalue their currencies, which could in turn descend into a damaging trade war when the Fed tries to sell all its government bonds back to the market, it may have to do so at a much lower price, leaving it dependent on the Treasury for a bail-out.