DJIA Courtesy: Yahoo Finance
What did he say?
- The Fed has decided to buy $ 40 billion worth of Mortgage Backed Securities every month continuously, until the dire unemployment situation improves
- This will drive down mortgage rates and encourage more home buying
- This will also drive mortgage investors to corporate bonds thereby increasing investments in other areas of the economy as well
What does this mean for the common man?
- More jobs? Maybe! Please refer to Case 1 on Monetary Policy to understand how interest rates are related to employment.
- A stock market bonanza? The stock market is very fickle. The benefit will last only until the next piece of news arrives. But we have already seen a 200pt improvement today and that is very good. With today's statement, the Fed has signaled to the market that it is willing to take bold steps to improve the economy and the market liked it.
4 comments:
Test Comments
Very good explanation Christina. Made it easy to understand this announcement especially it's effects on us citizens. Is there a threat of inflation?
40 billion? Every month? Which may or may not pull down interest rate on mortgage.
I think the interest rates in US are one of the lowest - around 1% or 2%. If the billions are transferred to places like India where the interest rates hover around 10% what will happen? It may generate employment in that place and generate income for US which may be used for creating more jobs.
Jonathan and Anon, both of you bring up important points. Here is my quick response to you and to a couple more questions that I received off line:
1. Where does the Fed get the $42bn every month? Does it borrow from China? The answer is No, the Fed just prints more money. Some folks can argue that printing more money is akin to encouraging government spending and indirectly borrowing from China, but that discussion can get very political and it is more to do with fiscal policy, which we will deal with later.
2. But the fact that the Fed will be printing so much more money, is what could lead to inflation, as Jonathan pointed out. This will happen when there is more money in the system than there are goods to buy. I think it will be a long time before we get there. We have to watch the Consumer Price Index to see how it impacts us. What we did see was a slump in the value of the US Dollar. But, the global economy is doing even worse than the US economy, so I think the dollar will recover as various other global central banks stimulate their economies.
3. That partially answers the second offline question, " If this was all it took to improve employment, why didn't the Fed do this sooner?" Inflation is the flip side to any quantitative easing and it is always a judgement call about how much is too much. This is the third Quantitative easing (QE3), the last two did not help too much
4. In response to Anon's question, interest rates when adjusted for foreign exchange usually reach an equilibrium state called 'interest rate parity' so investors can be indifferent to the geography of the investment.
I will add more material on both inflation and IR Parity soon. Thanks for your comments!
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