Wednesday, October 29, 2014

Feds Announce the End to the Era of Quantitative Easing

The Federal Reserve announced a discontinuing of the controversial bond buying program at the end of October this year. They will keep the short-term rates around 0 for the near future.  To this point, the risk to inflation is relatively low and the economy has shown mixed signals of strength in the last year or so. The Federal Reserve seeks to support the  3% projected national growth rate while not undercutting gains in the employment market. 

Lower Unemployment and Skepticism

Unemployment dropped to 5.9% but wages have not risen to provide an income boost. Most Americans are still skeptical of the economy and feel that improvements will occur sometime next year. They are not sure when next year but “sometime” seems to be the target spot. It is skepticism that is a result of not seeing high paying jobs and wage increases.

Bond Purchases

The bond purchases were controversial from the beginning but were seen as one avenue of encouraging development out of the world’s longest recession. Since 2008, the Fed’s investment holdings are around $4.5 trillion making them unprecedented in history. As the amount rises, so does the cost of debt, at a time where budgets are anything but balanced. 

The whole purpose of quantitative easing was to reduce interest rates to spur borrowing and improve economic activity (Newman, 2013). Theoretically, as interest rates decline businesses find it cheaper to expand operations and build more factories and businesses. It ignores the high rates of cash many of these businesses are sitting upon. 

As debt increases so does its overall costs. It becomes counter-intuitive to hold so much debt without reasonable assurance when and how it will be paid back. Long-term liabilities in business and government can be risky if the situation changes, another recession occurs, or the costs of servicing that debt rise unexpectedly. The Fed has ended an era of Keynesian induced development. 

Low Interest Rates

Keeping the interest rates low at a time when inflation risks are low is beneficial. Low interest rates can be a spark for development and investment (Dunlap, 2013). That development can be in the form of business growth, housing, or spending. As money stays cheap people will naturally spend more because it is easier for them to borrow than to save. 

Economic Optimism:

One factor that is not discussed in all the high finance terminology is optimism. American businesses must feel as though their future prospects will be lucrative. Investors want to feel that by borrowing and spending today they will reap significant rewards tomorrow.  Their analysis and decision-making leads to the conclusion that the economy will continue to get better and expand leaving them ample room for profit. If they perceive the economy will not get much better it makes more sense to purchase less risky investments or hold their money in the bank until brighter days are again apparent. 

Newman, R. (2013). A boost from the Fed. U.S. News Digital Weekly, 5 (10). 

Dunlap, N. (2013). Interest rates, the economy, and the market marionette. Journal of Property Management, 78 (6).

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