As the economy improves changes in Fed policy is likely but what action the Reserve will take is open to debate. The question was proposed by Tim Worstall in an article entitled, Should The Fed Raise Interest Rates Or Reverse QE First? It is an important one as policy makers decide what they are going to do with this long-term debt while still trying to support America's re-emergence.
It should be remembered that the purpose of QE was to stabilize the banking system that found itself without capital reserve not too long ago. As a crisis aversion tool the goal was to increase government debt through the buying of securities thereby putting more electronic cash, hence reserves, into the banks to avoid major defaults that could have dragged the economy down. It became a crisis averted by transferring risks from the private sector to the government.
As a policy stabilization made sense during a bank crisis but makes less sense as the economy recovers. The need to keep the liquidity of money flowing throughout the economy has dissipated and QE has stopped. According to the Heritage Foundation debt moved from $870 billion to $4.4 trillion in 2014. The nation must now deal with this debt and find ways of pushing it back into the private sector.
Sustained debt has an increasing risks to a nation that seeks to enhance its economic position. As debt levels rise, the cost of servicing that debt also increases which has an impact on growth rates (Turner & Spinelli, 2012). In comparison, European nations have experienced a flatter growth rate due to unsustainable debt levels. Maintaining such high debt not only causes a drag on the economy but also increase risks of impotence when and if future crisis occur.
Higher amounts of debt ratios, as a percentage of Gross Domestic Product, eventually raises interest rates (Hsing, 2010). Higher T-bill rates also caused inflation to move upwards over the long run. Debt levels, interest rates, and inflation seem to have a connection that creates the right framework for economic growth.
Raising interest rates helps fight against inflation. By making money less available the government can ensure that growth stays within its target rate and doesn't heat up too quickly. By returning the debt back to the private sector it will fight against inflation by soaking up extra electronic currency that stimulates short-term demand.
Instead of officially raising interest rates it may be better to start unloading the debt in adjustable chunks giving the Federal reserve an opportunity to gauge the economy and its momentum at each stage. This will give more control to the government, raise interest rates, and work toward better debt management processes. Moving debt off of the balance sheet may just help us out in the future if another economic crisis rears its ugly head.
Hsing, Y. (2010). Government debt and long-term interest rate: application of an extended open-economy loanable funds model in Poland. Managing Global Transitions, 8 (3).
Turner, D. & Spinelli, F. (2012). Interest-rate-growth differentials and government debt dynamics. OECD Journal: Economic Studies.
The blog discusses current affairs and development of national economic and social health through unique idea generation. Consider the blog a type of thought experiment where ideas are generated to be pondered but should never be considered definitive as a final conclusion. It is just a pathway to understanding and one may equally reject as accept ideas as theoretical dribble. New perspectives, new opportunities, for a new generation. “The price of freedom is eternal vigilance.”—Thomas Jefferson
Showing posts with label Federal Reserve. Show all posts
Showing posts with label Federal Reserve. Show all posts
Tuesday, January 27, 2015
Wednesday, October 29, 2014
Feds Announce the End to the Era of Quantitative Easing
The Federal Reserve announced a discontinuing of the
controversial bond buying program at the end of October this year. They will
keep the short-term rates around 0 for the near future. To this point, the risk to inflation is
relatively low and the economy has shown mixed signals of strength in the last
year or so. The Federal Reserve seeks to support the 3% projected national growth rate while not
undercutting gains in the employment market.
Lower Unemployment and Skepticism:
Unemployment dropped to 5.9% but wages have not
risen to provide an income boost. Most Americans are still skeptical of the
economy and feel that improvements will occur sometime next year. They are not
sure when next year but “sometime” seems to be the target spot. It is
skepticism that is a result of not seeing high paying jobs and wage increases.
Bond Purchases:
The bond purchases were controversial from the
beginning but were seen as one avenue of encouraging development out of the world’s
longest recession. Since 2008, the Fed’s investment holdings are around $4.5
trillion making them unprecedented in history. As the amount rises, so does the
cost of debt, at a time where budgets are anything but balanced.
The whole purpose of quantitative easing was to
reduce interest rates to spur borrowing and improve economic activity (Newman,
2013). Theoretically, as interest rates decline businesses find it cheaper to
expand operations and build more factories and businesses. It ignores the high
rates of cash many of these businesses are sitting upon.
As debt increases so does its overall costs. It
becomes counter-intuitive to hold so much debt without reasonable assurance when
and how it will be paid back. Long-term liabilities in business and government
can be risky if the situation changes, another recession occurs, or the costs
of servicing that debt rise unexpectedly. The Fed has ended an era of Keynesian
induced development.
Low Interest Rates:
Keeping the interest rates low at a time when
inflation risks are low is beneficial. Low interest rates can be a spark for
development and investment (Dunlap, 2013). That development can be in the form
of business growth, housing, or spending. As money stays cheap people will
naturally spend more because it is easier for them to borrow than to save.
Economic Optimism:
One factor that is not discussed in all the high
finance terminology is optimism.
American businesses must feel as though their future prospects will be
lucrative. Investors want to feel that by borrowing and spending today they
will reap significant rewards tomorrow. Their analysis and decision-making leads to
the conclusion that the economy will continue to get better and expand leaving
them ample room for profit. If they perceive the economy will not get much
better it makes more sense to purchase less risky investments or hold their
money in the bank until brighter days are again apparent.
Newman, R. (2013). A boost from the Fed. U.S. News Digital Weekly, 5 (10).
Dunlap, N. (2013). Interest rates, the economy, and
the market marionette. Journal of
Property Management, 78 (6).
Monday, October 20, 2014
When Opportunities Dry Up-Income Inequality in America
Income inequality is a hot topic that is becoming
more troublesome every year as the gap in incomes continues to grow. Fed Chair Janet
Yellen discussed on October 17th the growing problem of income inequality and
its potential impact on the American Dream. She elaborated on how child
resources, higher education, entrepreneurship, and inheritance influence a
family’s ability to raise their position in life. Without ensuring that there
is sufficient mobility within society there are risks to the founding fabric of
opportunity within the country.
Those who are not wealthy are finding it difficult
to save money or pass that money onto future generations. At the same time, those
at the top of society are discovering that it is not only easier to earn more
money but also save that money for their children. Additional time without
change seems to aggravate the problem.
Janet Yellen discusses four possible solutions that
include early education intervention, affordable higher education, business
ownership, and inheritance income. Each
of these points has some influence on whether someone will be successful beyond
the natural variations in human skill and abilities. They provide some
formation of doable change but are not a complete solution in and of themselves.
When society invests in children they can give them
better opportunities to learn, obtain quality education, and then apply those
skills to the market to earn higher wages. Owning a business is seen as another
way of generating wealth outside the restricted compensation structures of
larger corporations. Helping families invest and pass on their savings to the
next generation is helpful for improving positions over time.
Pure wealth distribution whereby money is taxed or donated
by major corporations or wealthy individuals will not help society grow in the
long run. Contrary to popular opinion, it
may actually do the opposite by lowering the need to achieve and succeed based upon
one’s individual efforts and merits. It can damage empowerment and societal development
of skill and ability which is needed to compete as a nation.
Fundamental change runs deeper than simply improving
skills and ability in isolation and delves into the nature of how opportunity
is created and rewarded in society. By focusing on rewarding core competencies
and skills the effects of income inequality can be lessened (Cobb &
Stevens, 2014). Where individuals have made effort to learn new skills there
should be corresponding increases in income.
Income inequality causes the lowering of incentives
for citizens who desire to engage the economic system fully. Where cynicism
grows also grows perceptions that effort doesn’t equal reward. When lower
income classes of the nation experience lost opportunity their empowerment declines
as success is something outside of their control. A sense of fatalism takes over.
As income inequality grows social instability rises
as a larger demographic of the nation feels that their needs are not
considered, government doesn’t adequately represent them, and success is
something they will never obtain. A study of 33 democracies worldwide found
that income inequality and regime stability were inversely related (Muller,
1988). Income inequality raises the natural conflicts over resources while the
system itself becomes less stable as these classes rub against each other.
The rising influence of the U.S. as a powerhouse of
manufacturing, innovation, and technology offers opportunities to re-balance the
ship for smoother sailing ahead.
Encouraging Americans to become more skilled and educated is helpful in
developing home grown talent that keeps jobs within the country. Wages should
keep pace with improvements in abilities to ensure that the nation retains its position as
a nation of opportunity for the vast majority of people. Income inequality is
one sign that changes in how we govern and the very nature of politics and
commerce must adjust to ensure the continuance of egalitarian principles
the country was founded upon.
Cobb, A. & Flannery, S. (2014). Those unequal
states: corporate organization and income inequality within the U.S. Academy of Management and Annual Meeting
Proceedings, p381-389. DOI:
10.5465
Muler, E. (2014). Democracy, economic development,
and inequality. Democracy, economic development, and income inequality. American Sociological Review, 53.
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