The Federal Reserve-as-economic-savior school took a beating yesterday, after the Fed's Open Market Committee announced its latest policy gambit to avoid a recession. Stocks promptly sold off on the Fed's comments that it now sees "significant downside risks" to the economy, and perhaps also as reality dawned that the reprise of 1961's Operation Twist is more gesture than salvation.
The Fed announced that through June 2012 it will buy $400 billion in Treasury bonds at the long end of the market—with six- to 30-year maturities—and sell an equal amount of securities of three years' duration or less. The point, said the FOMC statement, is to put further "downward pressure on longer-term interest rates and help make broader financial conditions more accommodative."...
The larger point is that the economy's problems aren't rooted in the supply and price of money. They result from the damage done to business confidence and investment by fiscal and regulatory policy, and that's where the solutions must come. Investors on Wall Street and politicians in Washington want to believe that the Fed can make up for years of policy mistakes. The sooner they realize it can't, the sooner they'll have no choice but to correct the mistakes.
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