Q&A: Did the Fed’s $4 trillion experiment work?

11/03/2014

Q&A: Did the Fed’s $4 trillion experiment work?

Q&A: Did the Fed’s $4 trillion experiment work?

 

NEW YORK (AP) – Oct. 30, 2014 – The $4 trillion experiment is over.

The Federal Reserve announced the end of its economic stimulus known as quantitative easing on Wednesday. Launched during the financial crisis in 2008, it was an unprecedented effort aimed at reviving a dormant economy through buying trillions in bonds. It also provoked a political backlash.

Q: Did the stimulus work?

A: It depends on who you ask. But many economists say the Fed accomplished the bulk of its goals. In the beginning, the Fed just wanted to stop the financial crisis from getting worse. It's impossible to know what would have happened without the Fed's help. But buying mortgage bonds, which many considered toxic at the time, arguably prevented more banks from failing and breathed life into frozen lending markets. The first round of quantitative easing was a rescue program. The second round, called QE2, was met with heated criticism.

Q: Why did people have such strong opinions about it?

A: Politicians, investors and even well-respected economists said pumping all that money into the banking system would cause the dollar to plummet and result in rampant inflation. They also feared bubbles in financial markets that would soon pop.

Q: What happened?

A: Since August 2010, when Fed Chairman Ben Bernanke argued for a second round of stimulus, the dollar has gained strength against major currencies and inflation has stayed tame. One widely used measure, the dollar index, has bounced around over recent years, but is currently 3 percent higher. Over the past year, overall prices have climbed a modest 1.7 percent.

Q: What has happened to the stock market since then?

A: If you made a bet on the stock market when Bernanke made his speech in the summer of 2010, your investment doubled. The most widely used benchmark for investment funds, the Standard & Poor's 500 index, has returned 101 percent since then, powered by a stronger economy, higher spending and record corporate profits.

Q: So now the Fed owns $4 trillion in bonds. Does it have to sell them?

A: No, they can sit on them. Some analysts wonder how the Fed will be able to unload its massive collection of bonds without disrupting markets. Very, very slowly, is the Fed's answer, and only if needed. One way is to stop re-investing money from bonds when they mature.

Q: What will the end of QE mean for markets?

A: Many investors expect more turbulence over the short term. In the bond market, the Fed's efforts have helped keep prices high and yields low. But there are plenty of other reasons besides the central bank's actions. Low long-term interest rates reflect sluggish economic growth, so slowdowns across the industrialized world mean government borrowing rates in Japan and Germany are even lower than U.S. rates. As a result, foreign banks and investors keep buying U.S. bonds – which has tugged rates lower and kept the yield on the benchmark 10-year Treasury note well below 3 percent for most of the year – the opposite of what market strategists expected.

Q: What about the stock market?

A: The big question for stock investors is: When will the Fed start hiking its benchmark lending rate? The move is expected to come at some point next year. Investors say more sharp swings in stocks are likely as that day draws closer. But there's general agreement on Wall Street that the central bank will increase rates slowly enough that it won't derail the U.S. economic recovery.

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