The Federal Reserve is hoping to discover a way to bring the U.S. back to where it way before the economy collapsed by working with the money supply. The Fed is buying 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. The public market should be able to get more money into it with this, called monetary stimulus or quantitative easing. Debt can be monetized with an expanding money supply meaning interest rates will, in theory, go down. Consumers and businesses should want to buy more with lending since saving won’t do them any good with low interest.
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. According to Reuters, this round is the second try of quantitative easing and can be called QE2, and this is, since 2008 when the Fed began purchasing assets, one of one of the most significant times for the country. Right now it appears that just the announcement of QE2 is having an opposite affect than planned. The Fed announcing an additional round of monetary stimulus means it is concerned about the economy’s state. The announcement made the market become a thing of doubt. Stocks plunged. Talk swirled of Japanese-style deflation, where no amount of monetary stimulus is enough to jump-start economic growth.
Fed gambling on the QE2
The People’s Voice reports that this can be a risky move the Fed is taking to announce a monetary stimulus. The Fed tried to help the housing crisis by up $ 1 trillion in securities from Fannie and Freddie which in turn made mortgage rates go super low. 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 cannot without forcing mortgage rates back up again. The Fed will be collecting principal and interest with this portfolio adding to billions. There is a lot of risk coming from monetizing debt. There might be foreclosures with a weakened market like this. If which were to happen to the fed, its portfolio would change to have billions of dollars of losses.
Liquidity trap
The monetary policy would be an excellent move for the Fed if the economy were textbook. But Daniel Indiviglio, writing within the Atlantic, said that it relies on the assumption that demand will rise to meet supply. Interest rates are already very low, yet businesses continue to sit on cash because they aren’t certain the demand will exist in the near-term to expand. Consumers are working on debt since they don’t know what the future holds. These conditions are what economists refer to as a liquidity trap. 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/
