The Federal Reserve is trying desperately to work with money and bring the economy in the U.S. back where it should be. 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. This practice, called monetary stimulus, or quantitative easing, injects cash into 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, businesses and consumers have no reason to not to borrow and spend more.
Fed’s monetary stimulus has a concern about the economy
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 the most significant monetary policy announcement for the Fed since it first revealed its intention to buy assets in late 2008. Right now it seems that just the announcement of QE2 is having an opposite affect than planned. The Fed announcing another round of monetary stimulus means it is concerned about the economy’s state. The announcement fueled a sense of doubt in markets. Stocks plunged. 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 suggests that the Fed’s move to do a monetary stimulus is a risky one. 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. Fed officials wondered publicly how they were possible going to get rid of all these securities. Considering economic recovery doesn’t appear to be happening, the Fed explained mortgage rates are likely going to have to be forced up once again. The Fed will be collecting principal and interest with this portfolio adding to billions. The cash coming in will be used to monetize debt and could possibly be a very risky move. This could make the housing market work meaning foreclosures. The Fed can have billion of dollars of credi! t losses on its portfolio when that happens.
Getting into a liquidity trap
The monetary policy would be an excellent move for the Fed if the economy were textbook. Daniel Indiviglio writes that this assumption is based upon off the fact that supply can be met by a rising demand. Interest rates are already low, but businesses haven’t been convinced yet that the demand is going to rise for products, so they sit on all of their money. Since the future is so uncertain, consumers want more than anything to just get out of debt. 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/
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