Over the last few weeks, I’ve been hearing a lot of people say that the Fed is somehow pumping money into the stock market, to try to make the economy look better than it really is. Is this really happening? Can the federal government buy stocks, or is the process more indirect?
Helpful:
http://online.wsj.com/article/SB20001424052748704082104575515853029748826.html
They don’t infuse the market with cash, per se, but the economics of interest rates do play a role in how much money is available. But this rally screams, “Short-term anomaly.”
Missed edit window again:
Fed has been buying assets. The Federal Reserve, not the Federal Government.
By keeping interest rates low, the FED is forcing money to stay in the stock market. Who wants bonds at <1% yields?
All of this will change, once the Obama Hyperinflation gets underway…look for a repeat of Jimmy Cartuh-style “malaise”-with inflation of 18-20%!
This is probably not what they were talking about, but the Treasury Dep’t. appears to be readying itself to sell off the shares of AIG that it owns, essentially ending the bailout of that company.
Flat interest rates (since they can’t go lower) have allowed the market to wiggle a little, and signs of some economic growth give some small am’t of confidence to investors.
However, only the short-term has potential for some upturn (temporary), but the long-term prognosis is woeful. Interest rates are going to climb, and the market does not generally climb with the higher interest rates. Stock market growth trends up as interest rates decline.
The rates will be raised whenever inflation crosses a certain threshold, and that is an inevitable issue with a growing economy. So, we desire/need growth in our economy (without growth, another 10% or more of the people are unemployable), but with this growth comes inflation, which can be held in check by higher interest rates (because higher rates take money out of the system). With less money in the system, prices can’t climb, because demand scales back.
Meanwhile, the stock market is not left in the best position. Less money to invest.
I don’t know if it would violate their charter and/or whatever statutes they operate under, but even if it were fair game, what would be the point? Presumably it would have to be primarily a political motivation, but at this point with only a month left to mid-terms, who are they trying to influence? I doubt that a large enough section of the electorate would be influenced by this recent rally as to their voting preferences, so it would be going to a great deal of trouble for no significant benefit.
Apparently lots of people (although <1% only applies to short term). There has been so much money going into bonds, pushing prices up, that there is much talk of a bond bubble.
See if the following answers some questions: More Fed action: How would it work?
I’m still reading it and so can’t comment, but thought it might be worthwhile…
There seems to be some interest in exactly how the fed and monetary policy affects the economy, so at the risk of being pedantic, I’ll offer a quick primer that some may (or may not) find informative.
The fed has 2 legal obligations. One is to promote full employment (which really means about 5% unemployment btw). The other is to insure the stability of the currency which for practical purposes means avoiding both inflation and deflation. However as with unemployment, the goal is not 0% inflation but something in the 1-2% range I believe.
The fed accomplishes these goals by controlling the money supply. Since the rate of interest on money can be considered the “price” of money, when the fed increases the amount of money in the economy, the price (rate of interest) goes down. Normally, lower interest rates will stimulate economic activity. Why? Because whenever a business plans a new project or venture, they have to compare the projected profits from the venture to their cost of funds. Obviously, the venture should produce a rate of return that substantially exceeds the cost of funds. The higher the cost of funds (interest rate), the fewer potential ventures will be profitable. That means less investment by business and therefore less economic activity.
However the fed doesn’t have to actually increase the number of dollars in the economy to produce this effect. Since major banks key their interest rates off of the rate that the fed charges them for loans, any move by the fed to raise or lower this rate will usually propagate out to the entire banking system.
Although the fed has not directly affected the money supply by using this technique, such a move still ends up having the same effect. The reason for this is a phenomenon known as the money multiplier. I’m going to gloss over this because otherwise it would be a bit more than just a tangent. But the basic idea is that banks can loan up to 80 or 90% of what their customers have on deposit. When those loans get deposited in other banks, they too can take 80-90% and make more loans. This goes on indefinitely. The result is that for every new dollar put into the economy, several more dollars are created.
I know that sounds like a fancier version of 3 card monty, but it’s actually true. The wikipedia entry linked to above (money creation through fractional reserve banking) actually does a pretty good job of explaining what happens.
But don’t get bogged down in the details right now.
This technique of manipulating interest rates to indirectly influence the money supply only works if you have a non-zero interest rate. When interest rates are so low that there is no room to reduce them further, THAT is when the fed has to intervene directly and actually pump dollars DIRECTLY into the economy. This is called “quantitative easing”. The translation is “making money easily available by increasing the quantity of dollars in the system”.
That is where we are now. The problem is that the first round of QE didn’t seem to go over as well as expected. You can see this from the calculated value for the money multiplier that is provided every other week by the St. Louis branch of the Federal Reserve (click here to see the value of the multiplier from 1984 to the present).
You’ll see that even as the fed was pumping trillions of dollars into the banking system, the value of the multiplier gradually decreased. In fact, things have been so bad that the multiplier has been under a value of 1.0 since December of 2008.
What does that mean - that the multiplier is less than one? Well, for every new dollar that goes into the banking system, less than one new dollar is created. Remember, the objective is to create a new dollar, inject it into the economy, and have it spawn more new dollars thus creating more economic activity.
With a multi of less than one, you’re still getting new money into the system, it’s just not doing much to stimulate economic growth. This is often referred to as “pushing on a string”.
The problem thus far, and the reason that the multiplier is so low, is that every new dollar created by the fed must first go through the member banks which technically own the fed. If those banks don’t take that money and use it to make loans, then it simply sits in their accounts with the fed as “excess reserves”. In terms of stimulating economic activity, it may as well not even exist.
The reason why the banks have behaved in such an unusual and unexpected way is a whole other can of chili. For the moment just consider it an immutable truth.
However, if you look carefully at the multiplier data, you will see that beginning around March of this year, the value of the multiplier ended its long, painful decline and began to rise. There has been some backsliding, but there is no doubt that the short to intermediate trend is up. That is a very hopeful sign because it means that the banking system may (possibly, hopefully, theoretically) be getting back to normal. That means that lending, and therefore money creation, may be in the first stages of returning to normal.
Now if you’ve been paying attention, there is one potential problem with all of this that should jump out at you. If lending does return to normal and we have trillions of dollars more than we need, then won’t that have the effect of causing inflation and concomitantly, result in the debasement of our currency (aka, monetization of our debt)?
Well, it’s not a foregone conclusion that this will happen, but it is certainly a possibility. How do you thing Bernanke will avoid this potential land mine? Can he avoid it?
thanks!
that was helpful.
I am aware that the recent increase in money supply hasn’t had much influence on economic activity or inflation. This puts a number on that effect.
As to what will happen in the future, of course no one (except the Obama critics) knows for sure. The Fed has announced their intention to withdraw this money from the banking system. When and how fast they do this will determine whether this cash causes inflation or another economic downturn. Or maybe they will thread the needle. That would make everyone happy (except perhaps the Obama critics).