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 is a gamble for the Fed to take
The Fed’s monetary stimulus is a risky move, according to The People’s Voice. Mortgage rates went down to record lows following the Fed bought $ 1 trillion in Fannie and Freddie securities as an attempt to help with the housing crisis. Getting rid of these securities was a concern Fed officials wondered publicly. Considering economic recovery doesn’t seem to be happening, the Fed explained mortgage rates are likely going to have to be forced up once again. Billions will be collected on this portfolio in principal and interest by the Fed. The cash coming in can be used to monetize debt and could possibly be a very risky move. There could be foreclosures with a weakened market like this. The Fed may have billion of dollars of credit losses on its portfolio when that happens.
Liquidity trap
A textbook economy would do really well with the Fed’s monetary policy being made. Daniel Indiviglio writes that this assumption is based off the fact that supply could be met by a increasing demand. Interest rates are already low, but businesses haven’t been confident yet the demand is going to rise for products, so they sit on all of their money. Consumers are paying down their debt and saving for an uncertain economic future. A liquidity trap is what economists call this. The economic recovery won’t be helped with lower interest rates if nobody is willing to borrow money.
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/
