b
y Keith Larson
Starting this month the Federal Reserve will begin buying $40 Billion of mortgage-backed securities each month to help stimulate the economy. Known as Quantitative Easing, it is the third time since the Great Recession of ‘08 that the Fed has used its ability to print money, then use it to keep interest rates low. What they attempt to do is influence consumer demand, this time targeting homebuyers. In a market economy such as ours, according to theories of John Maynard Keynes, the government has two types of economic policies to affect demand — fiscal policy and monetary policy.
Monetary policy is under the control of the Federal Reserve System and is completely discretionary. In a recession, the Fed will lower interest rates and increase the money supply. In an overheated expansion, the Fed will raise interest rates and decrease the money supply. The policy changes can be done immediately, although the impact on demand can take several months.
Fiscal policy is changes in the taxing and spending of the federal government for purposes of expanding or contracting demand. According to Keynes, a recession requires deficit spending while an overheated expansion requires a budget surplus. One way this can be done is through the federal budget process. However, this process takes so long — 12 to 18 months — that it is difficult to match fiscal policy with the business cycle. The expansionary Kennedy tax cut of 1964 and later contractionary Ford tax increase of 1974 hit the economy just when the opposite policies were needed.
Expected effect of QE III: 1. Home mortgages will remain at historic lows, stimulating a market that has already hit bottom and is rebounding. August sales in nearby San Diego North County show a 6-year high; in SW Riverside County buyers closed on 1,115 homes, up 1.9 percent from July (though down 6.5% from Aug ’11), and prices rose in 11 of the 18 zip codes. As housing rebounds, buyers will purchase washers, refrigerators, etc and stimulate the broader economy, at least in theory. 2. The stock market will go up, as expectations of a recovering economy boost investor confidence. Also, low bond yields will continue to drive investors into stocks, further driving up prices (though artificially). This may encourage corporations to hire. 3. Eventually, the policy of printing money will lead to inflation and higher interest rates. The Fed knows it is treading dangerous waters and vows to monitor it closely.
Monetary Vs Fiscal Policy: Our government’s current inability to agree on fiscal policy is driving us to a “fiscal cliff” of expiring tax cuts and across-the-board spending cuts. This has the potential to drive us into another recession, which will offset the Fed’s monetary policy.
Keith is 1 of 30 experienced volunteers providing FREE business counseling in the Inland Empire. To make an appointment, send an e-mail to k.larson@%20cox%20.net“>k.larson@ cox .net. Or visit the SCORE website at http://www.inlandempire.scorechapter.org/. Join Keith and dozens of other Murrieta area business owners at a FREE monthly Business Roundtable, held 3rd Wednesdays from 7:30 -8:30 AM at Murrieta Public Library, 8 Town Square, Murrieta.