In Federal Reserve Chairman Ben Bernanke’s recent semi-annual report to Congress on monetary policy, Bernanke attempted to show that the Fed is not “out of bullets” when it comes to ways to stimulate the economy. However, having implemented a zero interest rate policy (ZIRP) with the target federal funds rate in a range between 0 and 0.25 percent, a policy the Fed may be locked into for another year or more, and also having purchased a multitude of mortgage-backed securities to backstop the mortgage market, the Fed may find itself painted into a corner with little ways to help a U.S. economy that is not growing nearly fast enough to create jobs.
Last year, the Federal Reserve intervened in the housing market, providing most of the funds for new mortgages. The central bank is stuck with dealing with those mortgage securities as demand builds for more economic stimulus. Holding onto the securities could be costly for the Fed and hinder its ability to battle inflation, according to The New York Times. Selling the securities could hurt the economy by draining money from it.
A wide range of economists say the Fed’s program — so big that purchases outstripped the issuance of new securities in some months — helped to preserve the availability of mortgage loans and helped to hold interest rates near record lows. Rates that exceeded 6 percent in late 2008 remain below 5 percent today. Certainly, the Fed’s asset buying programs have worked, but it cannot hold those securities forever, and selling them anytime soon would be difficult to do without draining the money from the economy, thereby hurting what little growth there is.
The issues surrounding the Fed’s interest rate policy are equally perplexing. Two economists recently noted in research on low-interest-rate traps, “Strict adherence to inflation targeting can produce interest rates that are too low, pushing the economy into a ‘low-interest-rate trap.’ Low interest rates induce too much risk taking and thus increase the probability of crises. Crises, in turn, require low interest rates to prop up the financial system. In a weakened financial system raising rates becomes extremely difficult, so central banks remain stuck in a low-interest-rate equilibrium, which in turn induces excessive risk taking.”
The U.S. is currently trapped in its ZIRP policy because raising rates would harm the fragile recovery. Bernanke reiterated the policy of the Federal Open Market Committee (FOMC) in his recent Congressional testimony: “Over the course of the crisis, the FOMC aggressively reduced its target for the federal funds rate to a range of 0 to 1/4 percent, which has been maintained since the end of 2008. And, as indicated in the statement released after the June meeting, the FOMC continues to anticipate that economic conditions–including low rates of resource utilization, subdued inflation trends, and stable inflation expectations–are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
This may explain in large part the yo-yo action in equity markets of late, as those who are concerned about lackluster growth that is almost entirely due to government, and not private, spending battle with investors will to take risks when cash is earning zero. The action will come to a head when either the economy shows clear signs of stumbling in the wake of reduced government stimulus and the Fed struggles with what to do to help (this could come in the form of another significant drop in home prices) or the Fed acts to relieve itself of its mortgage assets and raises rates. Investors, stay tuned.
Gregg D. Killoren
victoria1014
