* QE3 could total $1.7 trillion in bond buys, analysts say
* QE2 was $600 billion; QE1 was $1.75 trillion
* Disagreement remains on its ultimate impact
By Ann Saphir
CHICAGO, Sept 14 The U.S. Federal Reserve's
third round of bond-buying could ultimately rival the size of
its first huge quantitative easing, which was widely seen as
The sheer scale of the program and the radical shift in
policy it marks will shape the legacy of Fed Chairman Ben
Bernanke, whose term may end before the buying is through.
The Fed initially disappointed some investors on Thursday
when it said it would buy $40 billion of mortgage-backed
securities each month. That is far less than the $75 billion a
month it bought in its second round of bond-buying, or the more
than $100 billion monthly tab for its first round.
But this time, the Fed has promised that "if the outlook for
the labor market does not improve substantially," it won't stop
buying and could ramp up its spending further.
Depending how the Fed defines "substantially" and how long
it takes to get there, it could end up buying bonds for several
years, adding $1.7 trillion or more to its balance sheet,
By comparison, the Fed's initial round of quantitative
easing, first announced in November 2008 as the U.S. economy
slumped into a deep recession, totaled $1.75 trillion .
"They've clearly committed to do what it takes to get
unemployment down where they want it," said Pierre Ellis, an
economist at New York-based Decision Economics. "There's no
To Ellis, the "big bazooka" of open-ended bond purchases --
designed to boost the economy by lowering borrowing costs --
won't have much immediate impact because the economy's main
headwind is uncertainty over fiscal policy and the outcome of a
That's a view shared by several of the central bank's
U.S. Treasuries sold off broadly on Friday and 10-year and
30-year debt yields rose to their highest levels since May as
the new stimulus spurred risk-taking in stocks, reducing demand
for bonds, and as bond investors feared inflation from the
Disappointment that Treasuries were not included in the
central bank's third round of quantitative easing added to the
selloff, traders said.
A rise in long-term yields runs counter to the goals of the
program, which include pushing down long-term borrowing costs.
Bernanke, whose term ends in January 2014, sought on
T hursday to tamp down worries that he is aiming for higher
inflation, which is near the Fed's 2 percent target. The goal,
he said, is to bring down unemployment, which at 8.1 percent is
well above what most economists believe it should be.
Still, he acknowledged the possibility that the Fed could
tolerate some period of higher inflation.
"If inflation goes above the target level, as we talk about
in our statement in January, we take a balanced approach," he
said at a press conference following the Fed's policy shift. "We
bring inflation back to the target over time but we do it in a
way that takes into account the deviations of both of our
objectives from their targets."
Many analysts say the Fed's latest program may exceed its
predecessors in size, and more importantly, also pack the
"We believe that with a strong commitment from the Fed,
progress in Europe and the passing of the U.S. election, the
U.S. economy will have a pretty decent shot at achieving
above-trend growth in 2013," Julia Coronado, an economist at BNP
Paribas, wrote in a note to investors.
Thursday's announcement could add another $1.2 trillion to
$1.7 trillion to the Fed's balance sheet, she said.
TIED TO THE MAST
The Fed has kept short-term rates near zero since December
2008, and Fed Chairman Ben Bernanke has led the U.S. central
bank into ever-newer territory to lower real rates further.
After the first round of bond-buying in 2008 and 2009, the
Fed resorted in 2010 and 2011 to a second round to ward off
deflation as the recovery faltered.
As he doubles down on quantitative easing, Bernanke's
approach looks flexible enough to win support from both ends of
the Fed spectrum - the doves who want more easing to bring down
unemployment, and the hawks who worry that more easing could
overheat the economy and spark inflation.
"Everybody likes tying it to economic conditions," said
Paul Ashworth, chief U.S. economist at Toronto-based Capital
Economics. He estimates the program could eventually grow to
between $960 billion to $1.44 trillion in size.
"The doves like this because they think the markets will
think it's even bigger" than QE2, he said. At the same time, "it
gives the hawks something, that if the economy picks up, they
can get this stopped."
The Fed did not say how big it expects its latest program to
be, but the clues are plain in its quarterly economic forecasts,
also published Thursday.
Only three Fed policymakers expect the unemployment rate,
now at 8.1 percent, to fall more than half a percentage point by
the end of next year.
If the Fed sees 7 percent as substantial progress, the
forecasts suggest continued bond buying through late 2014; if a
bit lower, bond-buying could be needed through mid-2015,
Ashworth said. Underscoring that interpretation, the Fed said
Thursday it expects to keep rates low until at least then.
Before the crisis, unemployment was closer to 5 percent.
Chicago Fed President Charles Evans has spent the last year
arguing strongly for the Fed to tie monetary policy more closely
to economic milestones by vowing to keep rates low until
unemployment fell below 7 percent.
Doing so, he says, would avoid the temptation of backing off
from easing at the first signs of economic strengthening. In a
series of speeches in recent months, he has likened a strong Fed
commitment to low rates to a modern-day Ulysses tied to the mast
of his ship, prevented from responding to the siren call of
premature monetary tightening.
While the Fed did not embrace Evans' 7-percent unemployment
rate target, it did adopt his view that the Fed should hold fast
to easy policy even after the recovery picks up speed -- a
historic shift in policy.
DON'T STOP 'TIL YOU GET ENOUGH
Any eventual ceiling on the size of QE3 looks sky-high. The
Fed may only buy Treasuries and agency-backed debt, and some Fed
officials say it has bought nearly as much of the U.S. national
debt as it can without impairing the market's function.
But with mortgage-backed securities, there is plenty room to
run: economists estimate the size of that market at more than $7
trillion, although the Fed would need to avoid disrupting the
Michael Gapen, an economist at Barclays, sees QE3 topping
out at $700 billion - slightly more than the second round of
quantitative easing, but less than half the first.
The impact, he said, could be limited to boosting economic
growth by a few tenths of a percentage point, although that
could be enough to generate momentum.
"If you can keep the economy persistently above trend, then
that has a self-reinforcing effect," he said.
Combined with the European Central Bank's vow to buy as many
bonds as needed from euro zone states -- on condition they
undertake reforms -- QE3 "has the potential to be very positive
for the U.S. economy," Gapen said.
However, he said one real threat to the economy remains: a
raft of tax increases and spending cuts that will automatically
take effect at the end of the year unless Congress acts.
But if lawmakers successfully avoid the so-called fiscal
cliff, the outcome for the economy could beat expectations and
ultimately trim the size of QE3.