- What does it mean? In conventional open market operations, the Fed buys or sells US government securities. The reality is a bit more complex, but that’s the basic idea. In open mouth operations, the Fed simply announces something about its future plans. In this case they announced they will keep the Fed funds rate low until the unemployment rate drops to 6.5%.
- Does it make sense? There’s sound logic to the idea that (expectations of) future policies affect current behavior. Lots of people are now adjusting their retirement plans or realizing capital gains on the expectation that tax rates will rise. So the basic idea makes sense.
- Will it work? There are a couple reasons to doubt it will have much effect on the economy. One is that it’s just talk: Why should we believe them, when they could easily do something different a year from now? And their current statement is so loaded with qualifications you wonder what they’re really saying. Second, it’s not clear monetary policy is capable of doing much here anyway. There’s a wide range of opinion on this, but my best guess (meaning I’m not sure) is that monetary policy is a secondary issue in the economy’s struggles. The Fed is doing what it can, but it’s probably not the solution to our problems.
- When will we know? We’ll never know for sure whether it worked, but the next year or two could give us some clues. Maybe that will resolve it, or maybe it will lead to the kinds of debates we’re still having about the causes of the Great Depression. Sad to say, but this isn’t an exact science.
One last thought. Stan Zin noticed another clever description of current Fed policy: Cochrane notes that the WSJ refers to the Fed’s “more cowbell” approach. If the reference eludes you, see here or talk to a teenager. My son recommends this app, good for an hour of mindless fun.