We’ve all heard about the Federal Reserve saying that they will begin “tapering” Quantitative Easing (QE) later this year. In this article, I will explain what QE means, how it has helped our economy thus far and what tapering will do to the economy in the short and long term.
Quantitative Easing is a government monetary policy which is used to increase the money supply by buying government securities (bonds) or other securities from the market. The Federal Reserve is a bank which is 1/2 privately owned and 1/2 government owned and is in charge of setting interest rates and keeping the unemployment rate steady. Through interest rates they can control inflation and the stabilization of our economy. Buying these securities will cause the government to print more money and supply the financial institutions with capital. A more technical way to explain this is that Quantitative Easing increases the money supply by flooding financial institutions with capital and it will provide liquidity. This is a great tool during a recession when companies are scraping for money, leading to people being laid off.
The Federal Reserve (Fed) is currently purchasing $85 billion dollars worth of Treasury and mortgage bonds, this adds up to $1.02 trillion dollars per year. In June, the Federal Reserve Chairman Ben Bernanke rocked the global financial markets by telling us that the Fed could begin to taper, or gradually reduce, it’s monthly purchases of $85 billion dollars worth of Treasury and mortgage bonds.
Since then, the markets have rebounded to record highs however after the announcement the financial markets fell tremendously. You might ask, why? A good analogy I like to use is that of a patient in the hospital receiving free world-class medical service. After the patient is treated and is in a much better condition he gets used to the world-class service from the nurses, but then is told by the doctor that, pretty soon he will be released. The patient remembers that he will not get this type of service at home or work so he is discouraged and upset.
Well ladies and gentleman, our financial markets are upset that they aren’t going to be offered money at nearly 0% interest or in other words “free money”. Their argument is that they aren’t feeling better even though every sector is hiring more and more people each month (except for the government, read “How The Sequestration Effects You“) and the financial markets are higher than before The Great Recession.
If the Federal Reserve starts tapering the financial markets will drop tremendously. This is a good thing because QE has caused an artificial inflation of prices and profits. It can even be argued that many companies aren’t really making profit from customers but are instead profiting from the nearly 0% loans that are offered to them.
If tapering begins, a market drop might occur for a few months, however investors will then realize that they are doing fine, just as the patient will start getting used to cooking his own food and doing his own chores. The Fed isn’t just going to stop the purchasing of $85 billion immediately, hence why it’s called “tapering.” After a few months the markets will stabilize and sustain “true value” levels, and judging by the past, eventually beat the market highs of today.
In conclusion, don’t believe the analysts that say the financial markets will collapse and this will lead us to another recession if the Fed starts tapering. They are comfortable from the “free money” that is offered to them and don’t want to be released from the hospital.
As always, if you have questions contact me @arberdoci.