Will QE3 Work?

Quantitative Easing 3 is upon us. Here is the explanation from The New York Times:

In September 2012, the Fed announced a new round of bond purchases, but with a difference. For the first time, it pledged to act until the economy improved, rather than creating another program with a fixed endpoint.

In announcing the new policy, the Fed sought to make clear that its decision reflected not only an increased concern about the health of the economy, but an increased determination to respond – in effect, an acknowledgment that its approach until now had been flawed.

The Fed said it would add $23 billion of mortgage bonds to its portfolio by the end of September, a pace of $40 billion in purchases each month. It will then announce a new target at the end of every month until the outlook for the labor market improves “substantially,” as long as inflation remains in check. The statement did not further explain either standard.

When the Fed decides to buy mortgage bonds, their reasoning is as follows: the supply of available bonds for the rest of us goes down, pushing the price of these bonds up and lowering their yields. (The price of a bond and its yield are inversely related because the formula for the price of a bond has the yield in the denominator being added to 1 and raised to the n power. As with any fraction, the bigger the denominator, the smaller the fraction.)

Lower interest rates are supposed to stimulate investment. Higher prices will coerce investors to purchase riskier assets such as stocks and corporate bonds. This is why the Dow and the S&P 500 did so well yesterday--after the announcement. The daily chart reveals that stock price movement was flat and then suddenly rocketed up.

The tone of the Times article by Binyamin Appelbaum was optimistic and hopeful. This is in stark contrast to the reporting of the Wall Street Journal regarding this issue. Jon Hilsenrath and Kristina Peterson's article in yesterday's Journal paints a more negative picture, as does the Journal editorial, "Bernanke Unbounded--The Fed Enters a Brave New World of Quantitative Easing." 

The Journal's perspective? QE3 will be marginally successful at lowering unemployment, with food and commodity prices going up while the value of the dollar deflates even further. This will further erode the value of savings, penalizing, among others, elderly people on fixed incomes. 

Here is an excerpt from the Journal editorial:

Mr. Bernanke was also as slippery as a politician in claiming that his policies don't promote deficit spending because the Fed earns interest on the bonds it buys and hands that as revenue to the Treasury. Yes, but its near-zero policy also disguises the real interest-payment burden of running serial $1.2 trillion deficits, while creating a debt-repayment cliff when interest rates inevitably rise. Does he really think Congress would spend as much if he weren't making the cost of government borrowing essentially free?

The Journal also questions the timing of Bernanke's actions--less than two months before the presidential election in November. If Mitt Romney wins and has his way, Bernanke will be replaced. QE3 may have the unintended consequence of saving his own job while the rest of us who are looking for work continue to be frustrated.