Should we Still be Worried about the Fed?

By Kara Odum '15 Over the summer, the Federal Reserve indicated that they were preparing to scale back their quantitative easing measures as the economy was starting to look stronger. The Federal Reserve, commonly called the Fed, is in charge of determining monetary policy in the United States to maintain a robust economy. For the past few years they have been trying to lessen the severity of the recession by printing more money to buy bonds, which helped keep interest rates near zero.

The Great Recession, which began in the U.S. in December 2007 and lasted through 2009, was started by a speculative bubble in real estate exacerbated by systematic mishandling of risky mortgage-backed bonds. Financial institutions were on the forefront of the collapse and subsequently were the first affected. The fall of Lehman Brothers sparked major panic in the financial world, forcing the Fed to step in by purchasing the now-defunct assets from the remaining financial institutions to keep them solvent.

Soon after the near-collapse of major investment banks, more lasting effects hit the rest of the country. Throughout the recession unemployment rates have been consistently high, foreclosure rates have gone up, the housing market has steadily declined, and the federal debt level has continued to climb.

To combat the latest recession, the Fed implemented an unprecedented expenditures program called quantitative easing (QE), which goes further than standard monetary policy. Usually, if the Fed is trying to give the economy a boost, it will decide to purchase bonds in order to increase demand. This in turn increases prices for the bond, thereby lowering their yield. This type of expansionary policy works to keep interest rates low or near zero to promote economic growth. This time, the Fed went further by buying other types of financial assets, not just bonds, from commercial banks.

The hope is that with additional funds available, banks will lend out more money so people can start a business, buy a home, etc. The initial loans create a domino effect: the people with the loans will go out and spend it in some form, giving those vendors more money to spend at other location, which will hopefully keep the cycle going. This process is why the Fed has continued its aggressive expansionary strategy for so long.  However, the economy has shown signs of improving recently, and so the Fed has suggested that they might start tapering future quantitative easing.

People in favor of ceasing the program argue that quantitative easing has been a useless expenditure, since the banks have not been loaning out more money than before as a result of future financial uncertainty. Also, there are fears that long-term inflation rates could be higher if quantitative easing continues. On the other side of the argument, quantitative easing has given the economy space to recover by ensuring that banks are capable of loaning out money and by increasing the nation’s money supply. The Fed’s actions have helped restore faith in the banking sector because even though they are not perfect the banks won’t default any time soon.

However, this past week the Fed announced that they would put off tapering quantitative easing, on the grounds of the fact that while the economy is getting stronger, there is still some concern about its recovery. Financial markets reacted positively at first since, for now, interest rates will remain low, but this reversal has others concerned about increased volatility in the market.

They are right to be worried. Anytime the Fed makes an announcement, markets respond almost immediately as shown in stock market drops and slowdowns in investing due to uncertainty, so it’s troubling to have the Fed backtrack on its decisions in a relatively short amount of time. While quantitative easing cannot go on indefinitely, the Fed needs to set a clear timeline for its plans instead of going back and forth on this issue.