The Fed’s Stimulus Strategy: Silencing Skeptics?

AMA9-16-14In the end, did hard easing work?

That contradictory term for Qualitative Easing version 3, the Federal Reserve’s controversial and much disputed stimulus plan, has been in the news and on the minds of economists and financial advisers since it was conceived in 2012 as the latest attempt to boost the nation’s economic recovery.

From the beginning, the plan to force interest rates to historically low levels faced harsh criticism from experts worried that it might do far more harm than good. But several months into the slow ‘tapering’ of the stimulus, the sky hasn’t fallen, interest rates haven’t skyrocketed, and the dollar has surged back stronger than ever. That’s news to silence the skeptics, but does it indicate a rosy future?

What’s Qualitative Easing?

QE3 is the third incarnation of “easing,” an unconventional strategy to jump start the economy by buying up securities and bonds in an effort to keep interest rates low. Banks that sold those securities to the government wouldn’t have to raise interest rates to consumers, who could then get more loans to buy more things, such as houses and cars.

Or so the theory went. This kind of strategy was first fielded back in 2009,the year after the famed bursting of the housing bubble and the historic collapse that saw millions of people losing their home to foreclosure and banks caught red handed in a variety of financial scams and schemes.

The nation’s consumer economy was in ruins. The banks held trillions of dollars in bonds and securities backed by mortgages – many of them held on foreclosed properties. Quantitative Easing version 1 was put into place in 2009, tapered lightly later that year and then rebooted as QE version 2 in 2011.

QE3, the current version, hit the scene in 2013 with the ambitious goal of buying up $85 billion worth of bonds and securities every month until further notice. When would the Fed “taper,” or wind down the plan? No one was exactly sure. It all depended on the health of economic indicators such as job growth and housing starts.

QE3 Under Fire

The very scope of the plan raised concerns. Criticism came from without and within, as the chairs of regional Federal Reserve banks expressed doubts that the stimulus would be sustainable.

Others worried that artificially holding interest rates to historically low levels thanks to the bond buyup would mean a drastic rebound once the stimulus was withdrawn. Rates would suddenly shoot up, they fretted. That could shut off the credit pipeline to millions of borrowers, casting a chill over the still recovering housing market and slowing the purchase of other kinds of high-end consumer goods. And that might depress the job market even further.

Other kinds of worries surfaced, too. Some analysts claimed that the plan, which was supposed to help average Americans get loans, actually did just the opposite, enriching banks, which happily took government money but never passed on those benefits to their customers.

International money market observers were also concerned. Thanks to the effects of the economic collapse, the dollar had suffered a bumpy ride in the global currency world, with cycles of slumping and then rallying briefly against other currencies such as the euro, pound sterling and yen. The plan also affected international interest rate calculators such as LIBOR, with ripples in markets halfway around the world.

Although critics had to grudgingly admit that the lower interest rates were helping to boost housing and help breathe new life into other areas of the economy, they weren’t convinced that the recovery would hold up once the Fed decided to really ease back on the throttle.

That didn’t happen until the early summer of 2014, when after months of debate and equivocation, the Federal Reserve under its new chair Janet Yellen opted to start a cautious tapering down, pruning a mere $10 billion off the monthly stimulus tab in response to better job numbers and more housing activity.

The financial world watched with bated breath. Critics waited to be vindicated.

But not much happened. Interest rates have begun a slow creep upward, pushed by market forces now that the Fed’s artificial manipulation is slowly being withdrawn. There’s been a slowdown in mortgage applications, but industry analysts blame tighter regulations ad stricter lender accountability for that as well.

Perhaps the biggest challenge to the plans’ naysayers comes from the performance of the dollar. Amid dire warnings that the stimulus could destroy he dollar and drive inflation to recorded levels, the greenback has surged in world money markets, posting its best performance in over a year.

What Investors Need to Know

The economy still isn’t in perfect health. And the Fed has the option of stopping –or revering – its taper-down if conditions worsen again. Interest rates can still raise more –and the housing market struggles with a 19 year low in homeownership. But as the dollar outpaces the currencies of countries that have taken a more conservative approach to managing their economic crises, even critics of “hard easing” are admitting that maybe the Fed was right after all.  (Featured image:Flickr/eguidetravel)

Sources:

Roesler, Matthew. “A Complete History of Quantitaive Easing in One Chart.” Business Insider. businessinsider.com. 25 Jan 2014.

Weisenthal, Joe. “We Might Be Witnessing the Final Humiliation of the Fed Haters.” Business Insider. businesinsider.com 16 Sept 2014

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The American Monetary Association Team

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