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 would really like to keep their rates down as low as they are and are doing so by taking interest from mortgage-backed securities along with getting U.S. Treasury notes and bonds. 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. Businesses and consumers will want to borrow and spend more, because savings basically earns no interest.
Fed concerned with the economic outlook and bringing forth the monetary stimulus
An earlier round of monetary stimulus during the economic downturn seems to have failed to spark a sustainable recovery. Reuters reports that the second round of quantitative easing, dubbed QE2, is probably the most important monetary policy announcement for the Fed since it first revealed its intention to buy assets in late 2008. Right now it appears that just the announcement of QE2 is having an opposite affect than planned. The economy must be in really bad condition if the Fed is willing to admit how bad the economy is with a monetary stimulus. Markets were doubted through the announcement. Stocks dived. 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 People’s Voice reports that this is a risky move the Fed is taking to announce a monetary stimulus. Mortgage rates went down to record lows after 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. Mortgage rates could be forced to go up because economic recovery isn’t getting better. Billions can be collected on this portfolio in principal and interest by the Fed. Using the cash to monetize debt is loaded with risk. The housing market could very well weaken further and foreclosures could rise. The Fed may have billion of dollars of credit losses on its portfolio when that happens.
Getting into a liquidity trap
The Fed’s latest monetary policy move makes sense on paper in a textbook economy. The demand, of course, is assumed to meet the supply, as outlined by Daniel Indiviglio. Interest rates are already very low, yet businesses continue to sit on cash because they aren’t confident that the demand will exist within the near-term to expand. Consumers are paying down their debt and saving for an uncertain economic future. These conditions are what economists refer to as a liquidity trap. No matter how low the Fed pushes interest rates, it won’t help economic recovery because nobody wants to borrow.
Discover more information on this subject
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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