The Fed's Stimulus Programs Have Their Critics But They Are Adding Stabiltiy To The Economy In Not So Obvious Ways

Thursday, November 29, 2012 20:58
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The Fed's Stimulus Programs Have Their Critics But They Are Adding Stabiltiy To The Economy In Not So Obvious Ways

Tags: business strategy | economy | Federal Reserve

The Fed has weathered plenty of criticism for its continued stimulus action, particularly with the third quantitative easing (QE3) that commits the Fed to buy $40 billion of mortgage-backed securities each month but there may be a hidden benefit. 

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This commitment is on top of the Operation Twist program that sells short-term Treasury bonds and purchases long-term debt.
 
The Fed hopes that keeping interest rates close to zero will encourage investors to move their money from safer instruments like Treasuries and into riskier, higher-yielding investments such as stocks and corporate bonds.
 
The higher returns will increase household net worth, increase the value of collateral banks use to make loans, and encourage businesses to invest.
 
Fed chief Ben Bernanke and his allies say that the stimulus programs are working although they are not enough to resuscitate the economy nor are they without risk.
 
Critics say the programs have not had much effect at all. But they are having a stabilizing effect on the economy because they are encouraging companies to rely less on short-term borrowing.
 
A large percentage—77.8—of non-financial companies are borrowing for a year or longer. Their chief financial officers (CFOs) are taking advantage of long-term rates they do not expect to see again in their lifetimes.
 
This encourages investors to also borrow longer term. But when interest rates begin to rise, investors other than pension funds (who hold bonds to maturity) may suffer destabilizing losses.
 
So the Fed plans to announce loudly in advance any plans to sell the longer maturities in its portfolio and raise interest rates.
 
For now, the economy can use all the stability it can get. And if the Fed can navigate the interest rate turn effectively, the shift to higher rates may be less disruptive.

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