Fed announces new stimulus, rejects pressure from GOP

The Federal Reserve announced Wednesday it would again try to spark the economy, ignoring GOP pressure to avoid more stimulus.

In a 7-3 vote, the Fed decided it would reorient its portfolio in a further attempt to lower long-term interest rates.

{mosads}Over the next nine months, the Fed plans to buy $400 billion in longer-term securities while selling off the same amount in short-term bonds. The move, which the Fed in a statement said would “help make broader financial conditions more accommodative,” borrows from a Kennedy-era effort dubbed “Operation Twist” and is aimed at stimulating borrowing and investment.

The Fed justified its decision by noting “significant downside risks” with the economy, including turmoil in global financial markets.

However, three members of the policy-setting Federal Open Market Committee (FOMC) dissented from the panel’s statement because they did not believe further accommodative policy was appropriate.

The same three members dissented from August’s FOMC statement, when the Fed announced it would be keeping interest rates near zero for at least two more years. It shows the Fed is divided over how much it should intervene in the economy.

While the Fed’s decision was widely expected by investors, it serves as a direct rebuttal to pleas from congressional leaders of the Republican Party.

On Monday, top Republicans in both chambers sent a letter to Federal Reserve Chairman Ben Bernanke saying they had “serious concerns” about further Fed stimulus. They also argued attempts did more harm than good.

“The American people have reason to be skeptical of the Federal Reserve vastly increasing its role in the economy if measurable outcomes cannot be demonstrated,” the lawmakers wrote.

The entreaty came as both parties have their eyes on the economy. High unemployment has hurt the poll numbers of House Republicans and the White House alike, and a poor economy could dash President Obama’s chances of winning a second term.

The GOP letter represented an unusually direct approach to critiquing the Fed’s moves. While politicians on both sides of the aisle have criticized a wide variety of the central bank’s moves, rarely has the leadership of one party so directly tried to sway the Fed’s monetary policy decisions.

Rep. Jeb Hensarling (R-Texas) contended Wednesday that since Bernanke has called on Congress to address the nation’s fiscal issues, lawmakers should be able to return the favor.

“I haven’t noticed the chairman of the Federal Reserve being reticent to offer advice and counsel to the Congress, so he should not be reticent to receive advice and counsel from the Congress,” Hensarling said after the Fed issued its statement.

He also indicated that the novel moves now being taken by the Fed might represent overreach.

“There’s becoming an unfortunate blurring between fiscal and monetary policy,” Hensarling said. “This right now is not your grandfather’s monetary policy.”

Sen. David Vitter (R-La.) called the Fed’s new policy foolish and said it was likely to fail.

“The Fed’s ‘Operation Twist’ is as soberly designed and wise as its name suggests,” he said in a statement. “I think the chances of it backfiring by ushering in inflation and devaluation of the dollar are much greater than the chances of it working.”

Financial market participants were somewhat surprised by the GOP’s decision to pressure the Fed.

“That is not something that I would like to see,” said Daniel Alpert of Westwood Capital. “People should respect the independence of the Fed. They should respect the smart people that are on the Fed.”

“I don’t know exactly what the point is,” said Brian Gardner, senior vice president of Washington research at Keefe, Bruyette & Woods. He said the last-second letter from the lawmakers was “not going to affect policy” or “move the Fed.”

The Fed by design is intended to be inoculated from political pressures in setting monetary policy. It does not have to obtain approval or even justify its decisions to either Congress or the White House.

But the Fed is no stranger to political pressure. Bernanke regularly testifies before Congress on a variety of matters, and the Fed can be altered via legislation. In addition, the majority of its policy-setting members are politically appointed. House Minority Whip Steny Hoyer (D-Md.) on Wednesday said Republicans had the “right” to pressure the Fed on its policies, as did Democrats.

The Fed under Alan Greenspan felt increasing pressure from President George H.W. Bush’s administration as his campaign geared up for its reelection effort in 1992. Bush officials wanted the Fed to lower interest rates more rapidly in an effort to boost the economy prior to the election. The Fed resisted, and Bush lost to Bill Clinton.

More recently, members of both parties have put forward bills to tinker with the Fed’s operations. Several Republicans have pushed bills that would trim the Fed’s mandate so it no longer focuses on employment, but merely inflation.

And House Financial Services Committee ranking member Barney Frank (D-Mass.) recently called for an overhaul of the Fed so that all its policy-setting members are politically appointed. He argued that the five regional Fed presidents who are not appointed skew policy with little accountability.

The Fed also announced Wednesday it would try to help the ailing housing market by reinvesting principal payments from debt and bonds from Fannie Mae and Freddie Mac back into those same bonds in an effort to lower those borrowing costs.

Updated at 8:17 p.m.