The U.S. Federal Reserve is making a bold effort to invigorate the American economy by announcing Wednesday it will buy hundreds of billions more in Treasury bonds.

Bay Street economists have their doubts about whether the Fed’s plan it will work or not.

Calling the Fed announcement, “perhaps the most anticipated Fed statement in decades”, TD Economics notes that the Federal Open Market Committee announced a second round of large scale Treasury bond purchases totaling US$600 billion. These purchases will be made through the end of the second quarter of 2011, and will take place in monthly increments of about $75 billion, it says.

Beyond that, any future asset purchases will be conditional on employment and inflation results, TD notes. For now, however, the Fed’s the economic outlook remains largely unchanged, with a slow recovery in output and employment.

“The size and timing of the Fed’s asset purchase program appears to have met financial market expectations,” says TD. “Five and 10 year bond yields dropped by 4-6 basis points immediately following the announcement. Likewise, stock markets were up slightly in what may have been a relief rally.”

RBC Economics notes that Fed president Hoeing dissented from Wednesday’s decision, “and said that he believes the risks associated with making additional purchases of U.S. Treasury securities outweigh the benefits. He maintained his stance that the maintenance of very easy policy is increasing the risks of future imbalances that may undermine the economy and fuel higher, long-term, inflation expectations.”

“The FOMC has internally struggled with the decision to do more quantitative easing,” adds TD, noting that concern over the threat of deflation is the main factor behind the decision to go ahead with the policy.

“The Fed must now walk a tightrope between communicating an expectation of continued economic weakness that justifies low short-term rates for an extended period, and an expectation that more QE will be successful in boosting economic growth,” TD says. “In intentionally raising expectations of future inflation, the Fed must be careful to avoid threatening itscredibility or dis-anchoring long-term expectations. The Fed wants people to expect some inflation, but not too much.”

Still, TD maintains that there are “considerable limitations” on how effective this sort of easing can be in boosting economic growth. “Credit will continue to be constrained by household deleveraging and uncertainty in the housing market, and there is little reason to believe that an additional $600 billion in reserves will significantly alter this paradigm,” it says. “At the very least, QE2 should succeed in holding down interest rates and give more time for the economic recovery to gain momentum.”

National Bank Financial says that this latest round of quantitative easing provides an insurance policy against deflation without creating credibility issues to the Fed’s exit strategy down the road. “From our point of view, the Fed’s actions would be more effective in creating jobs if complemented by additional fiscal stimulus and less regulatory uncertainties. Unfortunately, the latest election results make it difficult to be optimistic of this front,” it says.

IE