Fed strategy presents risk
Letter to the Editor by: Sam Orman, Junior, Finance and Business Econ.
The Federal Reserve decided, in the middle of September, to continue with bond purchases and to forgo tapering for the time being. This was a signal that its goals for unemployment and inflation have not been reached and the equity market remains irrelevant in the decision process. The Federal Open Market Committee voted an astonishing 9-1 in September to continue with the bond buyback program.
The Federal Reserve, with holding rates that are artificially low, has made borrowing exceptionally cheap. This crutch has allowed Washington to do what they do best: spend now and leave the consequences for someone else. Keeping interest rates low allows politicians to prolong difficult decisions regarding spending. The announcement of Janet Yellen’s nomination to Federal Reserve Chairman provides further evidence that tapering is not in sight, due to her support of the current Fed policy.
Quantitative easing is merely a stimulant measure to revitalize growth after downturns occur. However, if the government continues to repeat the process, it can keep price signals from being properly transmitted, creating economic distortions. The low yield within the bond marketplace has caused investors to take on more risk and seek higher yields. Retirees are pinned. Instead of placing money in bonds that will meet their required return, people adverse to risk have been forced into riskier assets.
This flight to yield was seen with the flow of funds into equities and junk bonds. These large inflows into equities have certainly reflected the performance of the market over the last few quarters, but do not reflect the healthiness of the economy. Long periods of quantitative easing can create an artificial inflation of the value of assets, thus providing the possibility of creating the asset bubble (mispricing assets) it sought to recover from in the first place.
Quantitative easing should not be thought of as the great problem solver. The process will not restore quality jobs to the workforce. This can only be solved through education and people’s willingness to obtain the appropriate skill, which undoubtedly takes time. Monetary policy can also not solve mismatching problems within the job market; for example, if there are too many construction workers the market must correct itself.
If interest rates are already low, the goal of increasing spending (through QE) becomes an impractical objective. People’s expectations of the market have already been established. While quantitative easing has certainly encouraged companies to expand, most companies are already fixated on the impending rise in interest rates; the expectations have been formed.
Anticipated rounds of quantitative easing have been proved to be less effective in increasing value, which conflicts with the Federal Reserve’s concept of increasing the transparency to the public. Companies are focused on becoming efficient and minimizing expenditures as borrowing costs rise.
Considering the minimal improvement in the employment environment and continuation of a growth recession, how can the Federal Reserve continue to rationalize stretching the balance sheet further? Labor participation rate has to the lowest level since the 1980s; the slow improvement of unemployment could be nothing more than people leaving the workforce.
The costs certainly outweigh the benefits, but quantitative easing continues solely based upon not reaching data points, without thinking about the long-term implications and artificial growth within the equity market. Quantitative easing will continue to encourage distortion within the equities market, continue to make bonds unattractive, allow cheap borrowing, cause people to take on risk, and not solve the issues facing the economy. Throwing money at the problem will not solve the economic issues, but quantitative easing will create the next bubble.