Friday, October 15, 2010

The Federal Reserve Actions Are Hurting-Not Helping

Next month, the Federal Reserve (Fed) interest rate setting committee, the FOMC, meets to consider changes in rates. Unfortunately for the U.S. economy, they have telegraphed that they intend to exercise more quantitative easing (QE).

What this means is that they have exhausted traditional weapons to combat the economic malaise and they intend to engage in the unconventional policy of buying long term U.S. Treasury bonds. This policy has the impact of reducing long term interest rates and pumping more dollars into the economy. There are two problems with this policy.

First, long-term interest rates and mortgage rates are already at historic lows. Lower rates will not stimulate greater consumer spending or home buying. In fact, by telling families that rates will remain low for the foreseeable future, potential home buyers are encouraged to delay the purchase in hopes of a lower home price combined with even lower mortgage rates down the road. Second, pumping more dollars into the system will result in excessive inflation as early as the second half of 2011, even more asset price bubbles (e.g. gold) and a fragile U.S. dollar. This will generate another round of economic unwinding in the near term.

So what should the Fed do? They should indicate that they will soon begin raising interest rates. This will encourage some home buyers that are currently on the fence to buy that new home. It would also shore up the confidence of investors and business owners who gauge QE as an extreme measure conveying Fed panic.

As the old saying goes, "when you've dug yourself into a hole, quit digging."
Ernie Goss

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