The Federal Reserve is experimenting with the money supply in an effort to bring a flagging U.S. economic recovery back on track. The Fed is getting U.S. Treasury notes and bonds and is also getting interest from mortgage backed securities to try and keep all the interest rates down to a near zero rate. This practice, called monetary stimulus, or quantitative easing, injects cash to the public market. The theory is that by expanding the money supply through monetizing debt, interest rates decline. Since saving doesn’t help earn any money, companies and consumers have no reason to not to borrow and spend more.
Economic outlook concern coming wit Fed’s monetary stimulus
The monetary stimulus was tried before and didn’t do anything to help the economy recover. Reuters reports the second round of quantitative easing, dubbed QE2, is probably the most significant monetary policy announcement for the Fed since it first revealed its intention to buy assets in late 2008. The announcement of QE2 has had a short-term effect exactly opposite of its intent. The economy must be in really bad condition if the Fed is willing to admit how bad the economy is with a monetary stimulus. The announcement fueled a sense of doubt in markets. Stocks went down. A Japanese-style deflation is the fear of every person meaning the economy can’t be helped with a monetary stimulus.
QE2 a big gamble for the Fed
The People’s Voice reports that this can be a risky move the Fed is taking to announce a monetary stimulus. To avert the worst of the housing crisis, the Fed purchased more than $ 1 trillion in Fannie Mae and Freddie Mac securities to push mortgage rates to record lows. Fed officials wondered publicly how they were possible going to get rid of all these securities. With economic recovery going south, they have concluded they can’t without forcing mortgage rates back up again. Billions can be collected on this portfolio in principal and interest by the Fed. Using the cash to monetize debt is loaded with risk. There could be foreclosures with a weakened market like this. The Fed could have billion of dollars of credit losses on its portfolio when that happens.
Falling into a liquidity trap
The monetary policy would be a fantastic move for the Fed if the economy were textbook. Daniel Indiviglio writes that this assumption is based off the fact that supply will be met by a increasing demand. Interest rates are already low, but businesses have not been certain yet the demand is going to rise for products, so they sit on all of their money. As the future is so uncertain, consumers want more than anything to just get out of debt. A liquidity trap is what economists call this. When nobody wants to borrow right now, it makes it impossible for the Fed to help by lowering all of the interest rates.
Reuters
reuters.com/article/idUSN1123481920100811
The Peoples Voice
thepeoplesvoice.org/TPV3/Voices.php/2010/08/11/monetizing
Atlantic
theatlantic.com/business/archive/2010/08/will-the-feds-new-monetary-stimulus-help/61327/
