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Quantitative Easing Program Confirmed by Federal Reserve

Interest-Rates / Quantitative Easing Oct 27, 2010 - 12:50 PM GMT

By: David_Urban

Interest-Rates

Not content on waiting to reveal to the markets after the conclusion of the November 3rd Federal Reserve meeting, the St. Louis Fed just published an article in the latest Monetary Trends entitled 'Is More QE in Sight?'


http://research.stlouisfed.org/publications/mt/20101101/mtpub.pdf

A short summary of the article extols the virtues of the first Quantitative Easing program which, according to two recent studies, lowered yields on 10 year Treasuries by approximately 100 basis points. 

The article focuses on two successes, the decrease in long-term interest rates and an increase in aggregate spending. The first is that by purchasing securities from the public the interest rate risk is lowered and market rates fall by the size of the risk premium.  The purchases are and have been funded by the creation of new deposits rather than the sale of short-term assets.

The second success is less clear in that the Federal Reserve realizes that business spending has been slow due to uncertainty surrounding the economic climate, not high interest rates and that businesses have not been constrained from borrowing and credit is available.

It appears from the one page article that the Federal Reserve's new QE2 program will be what the market expected in that the Fed will print money and using said money to buy long-term securities.

On an additional note, Fed Governor Bullard was quoted as saying that he is in favor of $100 billion to start and the Fed basically plays it by ear thereafter.

How successful the program will be is up for debate since the biggest hurdle surrounding the QE2 program is the uncertainty in the residential and business climate. 

By only committing to a one month plan the Fed will not have enough time to gauge the reaction of the business community and consumers effectively after one month. 

It has been said that moves in the Federal Funds rate take on average 6-9 months to work their way through the system so a one month commitment looks to fall short.

In a recent poll consumers were asked what they would do with a 10% raise and the most top answer was to save or pay down debt, the opposite of what the Federal Reserve desires or needs to happen.  The more people choose saving and debt reduction over consumption the more likely we are to continue in the current environment.

By David Urban

http://dcurb.wordpress.com/

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