Why the Federal Reserve Bank Isn't...ReservedSubmitted by Retire Source Wealth Management on October 11th, 2021
Why the Federal Reserve Bank Isn't...Reserved
I can already hear the questions. Who is the Federal Reserve Bank (the Fed) and why do I care? The Fed is the country's central bank and holds enormous economic powers. It is independent of the U.S. Treasury, the President, and Congress. It was created in 1913 to help quell a string of runs on banks by being the lender of last resort. During times of distress, such as the 2008 financial crisis, the Fed provides the additional cash (bailouts) required to help prevent the banking system from freezing up. In the 1970s Congress gave the Fed two new goals of maintaining price (inflation) stability and full employment. This took the Fed from a relatively passive entity to an active economic influencer.
The Fed has several tools to carry out their dual economic goals. It's primary tool is setting short term interest rates. Lowering rates makes loans cheaper which stimulates economic activity. Following the outbreak of COVID-19 the Fed set short term interest rates to near zero to help support their goal of full employment. However, they quickly deemed this as insufficient to the task at hand.
Next it pulled out its biggest gun, creating new dollars. There is a huge market for bonds and mortgage backed securities, predominantly used by mutual funds and institutions. The Fed used some of these new dollars to buy these investments in massive quantities, which had the effect of pushing down longer term interest rates, including mortgage rates. The result was a booming housing demand and rapidly increasing housing prices. The Fed also used some of those dollars to buy government bonds from the U.S.Treasury, who in turn used some of that money to push dollars out to the public via successive rounds of stimulus checks. The result was a big jump up in consumer purchases, which in turn helped fuel some of the shortages and price hikes we see today.
The Fed's massive economic actions were unprecedented. Their spending was equal to about 20% of total economic output. The new money they created increased the number of dollars in the system by 25%-30%, far beyond anything we've seen before. Historically, too many dollars in the system has proven to be fuel for inflation. Remember the Fed has a mandate to maintain price stability (inflation), the opposite of what we are now experiencing. Now the Fed faces the inflationary consequences of their aggressive economic stimulus. The Fed's tools to control inflation are the same tools they recently used, only run in reverse. The Fed can take money out of the system or raise interest rates. These actions are generally negatively received by the stock market since they slow the economy. In hindsight, the Fed's actions might have been overly aggressive. They abruptly swerved to avoid the recession ditch, only to slingshot across the road headed for the inflation ditch. Let's hope the Fed can get up back on a straight and sustainable path. This is no time for any of us to fall asleep at the wheel.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.