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Fed remains dubious of economy as investors cheer stimulus

You just never know how the financial markets will react to the Federal Reserve and announcements from Chairman Ben Bernanke on monetary policy. Most of the time it is a big yawn bordering on disappointment, but this past week proved to be just the opposite.

On Thursday the Fed’s Open Market Committee did what most observers had anticipated: opened up the money tap with another massive infusion of funds to, as the Fed statement suggests, “put downward pressure on long-term interest rates, support mortgage markets and help to make broader financial conditions more accommodative.”

The committee agreed to increase policy accommodation by purchasing additional mortgage-backed securities at a pace of $40 billion a month.

Alan Gin, an economics professor at the University of San Diego, said the move by the Fed is a positive but that the impact is likely to be small.

“As the Great Recession showed, there are limits to what monetary policy can do," Gin said. "The Fed can drive interest rates down, but it can’t make people borrow money or make banks lend it.”

He says the historically low level of mortgage interest rates has contributed to the recent rebound in housing prices and home sales.

The stock market rallied on the announcement, with the Dow Jones Industrial Average gaining more than 200 points and closing to within 4 percent of a new all-time high previously set in October 2007.

Investors must have been taking a long-term view of the impact from the Fed move. The statement released after the central bank’s two-day meeting was less than optimistic.

“The committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions," the Fed statement said on Thursday. "Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. The committee also anticipates that inflation over the medium term likely would run at or below its 2 percent objective.”

Even with the latest round of quantitative easing, the Fed’s own projections for the labor market are cautious. In a supporting document with the report, the Fed suggested the unemployment rate, currently at 8.1 percent, will range between 7.6 percent and 7.9 percent next year and between 6.7 percent and 7.3 percent in 2014.

Even the Fed’s own forecast for economic growth is limited despite the massive infusion of funds. It estimates the gross domestic product will grow between 2.5 percent and 3 percent in 2013. And it sees the GDP topping out at 3.8 percent in both 2014 and 2015.

In poker terms, it appears Bernanke has gone all in to break the economy of a long, painful slump. And, that means his reputation — and job — are likely on the line.

“It will be years before unemployment gets back down to its historic norms," said Diane Swonk, chief economist at Mesirow Financial. "I doubt Ben Bernanke will still be in office to see it. But the Bernanke Fed would rather try and fail, than go down in history as not having tried at all.”

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