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Side Effects from the Federal Reserve’s Monetary Policy Program

Interest-Rates / US Interest Rates Dec 10, 2012 - 07:32 AM GMT

By: InvestmentContrarian

Interest-Rates

Sasha Cekerevac writes: The historic and unprecedented action by the Federal Reserve in enacting extremely loose monetary policy is an attempt to stimulate the economy. I’ve always felt that a central bank should have one mandate: the stability of the currency. The Federal Reserve has a dual mandate; in addition to keeping inflation in check, the American central bank also is attempting to lower the unemployment rate through monetary policy, a task not easily achieved.


Over the last couple of years, we have clearly seen that, while the economy has started to improve, it is far below potential gross domestic product (GDP) growth levels. Even with the historic monetary policy initiatives, the Federal Reserve is limited in what it can and cannot do. While the Federal Reserve may have good intentions, there are serious consequences due to unintended outcomes.

Through monetary policy action the Federal Reserve is attempting to increase the wealth effect by increasing asset prices. The thinking is that the wealthier people become through the increase in their assets, the more likely it is that they’ll be willing to spend. This action is one reason why we’re seeing gold prices go up, as well as the stock market and home prices since 2009.

Recently published data show that at least this part of the plan by the Federal Reserve is working, as the net financial wealth for Americans increased by $1.7 trillion to $64.8 trillion for the third quarter 2012. According to the Federal Reserve, this is the highest level of net worth by U.S. households since 2007. (Source: “U.S. household wealth rises to near 2007 high,” Reuters, December 6, 2012.)

The goal of this easy monetary policy program is to make assets attractive, which entices people into the markets and raises prices, generally. The higher prices go, the more wealthy people feel. Clearly, we’ve seen several markets have significant increases in price since 2009, including housing, commodities like gold, and the stock market.

Of the total increase in wealth, approximately $300 billion was from real estate and $520 billion was from the increase in the stock market. The good news, in addition to the overall increase in net wealth, was that households continued reducing their debt levels this quarter by $65.5 billion, approximately a two percent annual rate.

The worry is that whenever you have such a drastic monetary policy program enacted by the Federal Reserve, or any central bank, there can be serious unintended consequences. The bubble in real estate, as an example, I believe, was partially fuelled by monetary policy that was far too loose in the early part of the last decade, leading to inflated prices. This encouraged households to take on excess levels of debt that were unsustainable, which led to the crash.

Currently, the total household liabilities for the third quarter are at their lowest level since 2003, at 112.7% of after-tax income. One issue I worry about is that the maintenance on this debt is paid at rates that are artificially low, pushed down by the Federal Reserve. If we were to utilize interest rates that are normalized and not unnaturally depressed by monetary policy, I would certainly worry about how many Americans could afford maintaining even this level of debt.

Another issue with monetary policy that’s too loose is that while a moderate rise in asset prices can be positive, wages are not increasing at the same rate, leading to a reduced level of disposable income for the average consumer. While those that are able to own stocks, commodities, or real estate will benefit by an easy monetary policy stance, the bottom portion of society will suffer. This is a problem that the Federal Reserve has acknowledged in its statements, saying that more needs to be done by Washington in creating structural reforms.

Ultimately, I believe the problem is that everyone is looking for a shortcut to fix serious structural issues. The politicians in Washington are so paranoid about getting reelected that they are unwilling to make the hard choices necessary to build a solid foundation for the economy. The Federal Reserve can only do so much through monetary policy. In fact, its attempts to do what lawmakers in Washington should be doing could create negative unintended consequences in the long run. It’s unfortunate that our leaders in Washington are more interested in winning votes than building a strong nation.

Source: http://www.investmentcontrarians.com/recession/side-effects-from-the-federal-reserves-mo...

By Sasha Cekerevac, BA
www.investmentcontrarians.com

Investment Contrarians is our daily financial e-letter dedicated to helping investors make money by going against the “herd mentality.”

About Author: Sasha Cekerevac, BA Economics with Finance specialization, is a Senior Editor at Lombardi Financial. He worked for CIBC World Markets for several years before moving to a top hedge fund, with assets under management of over $1.0 billion. He has comprehensive knowledge of institutional money flow; how the big funds analyze and execute their trades in the market. With a thorough understanding of both fundamental and technical subjects, Sasha offers a roadmap into how the markets really function and what to look for as an investor. His newsletters provide an experienced perspective on what the big funds are planning and how you can profit from it. He is the editor of several of Lombardi’s popular financial newsletters, including Payload Stocks and Pump & Dump Alert. See Sasha Cekerevac Article Archives

Copyright © 2012 Investment Contrarians- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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