Here’s an economic irony for you. Less inflation means lower prices for you and I. However, to some who work for the Federal Reserve, that means things are off target and the economy still needs more work. Huh? What? It seems slightly fuzzy, but when you look at the larger macro-economic picture, things slowly start to come into focus. To a certain extent, inflation is actually good for the economy. The slow growth of inflation is one of many variables that is prompting speculation about whether or not the Federal Reserve should start tapering back its quantitative easing (stimulus) of the economy.
Recent Inflation Drop Prompts Speculation
In the May 2013 release of the April data, the inflation rate fell to 1.06%, which is the lowest it has been in two years. It was also the quickest drop since oil prices plummeted December 2008. According to St. Louis Federal Reserve Bank President, James Bullard, “Inflation has been, by our preferred measures been about 1 percent over the last year—way below our target.” Many people have assumed that with inflation levels still being low, that the Federal Reserve would continue to keep things on an even keel and not make any drastic moves that would affect the economy. However, not everyone at the Fed feels that way.
Federal Reserve Chairman, Ben Bernanke, implied in May that the Fed may consider curtailing their current $85 billion monthly bond purchase program. Although, he did add the stipulation that they would only do so if market conditions continued to show improvement. The Federal Reserve began this buy-back program in September 2013 and there are indications that it is helping the economy. With the stock market at record highs and growth in the housing market, as well as a tiny drop in unemployment, Bernanke thinks it may be time to taper back.
The Implications of Tapering the Bond Program
The problem is that many financial markets don’t agree with Bernanke. For example, the same week that Bernanke made his statement, mortgage interest rates went up by 3.71% because of fear that the Federal Reserve will start cutting back its bond purchases. Unfortunately, that the type of “market hysteria” is what the Federal Reserve is trying to avoid. Bernanke has indicated that by reducing purchases, they are simply slowing down the rate that the Fed is stimulating the economy, but not actually doing less for the economy’s growth.
Eric Rosengren, the president of the Federal Reserve Bank of Boston, said “Thus the effect of our purchases ultimately depends on whether they result in a larger or smaller balance sheet for the central bank, which in turn depends on when the purchase program ends, given the pace of purchases. If asset purchases at a lower rate were to continue for longer than they would otherwise, the Fed’s balance sheet could actually grow larger than it would with more sizable purchases over a shorter period.” Rosengren feels that reducing bond purchases and continuing them longer will add to the Federal Reserve’s overall balance sheet, but what that implies for the economy is uncertain.
Other Factors to Consider
Many people, both government officials and private citizens, feel the economy is still recovering from recession. According to figures cited by debtconsolidation.com, over 1 million people filed for bankruptcy last year. Unemployment is still higher than average and the slow rise of inflation is because wages are low and people are spending less.
Not all quantitative easing measures have been good for everyone. For example, the Fed has been keeping interest rates low for an abnormally long time because of the severity of the recession. In turn, this has hurt long-term savers who aren’t generating the returns on their retirement accounts that they need in order to comfortably retire. With many people fearing for their future, they have turned to cutting back on expenses and spending less in order to save more for their retirement, thus causing inflation to remain low and slowing full economic recovery.
The Big Picture
Even officials who work for the Federal Reserve disagree on whether or not tapering the bond purchase program will help or harm the economy as a whole. As with any type of government stimulus program, there are benefits and drawbacks of the current bond purchasing system. Over all though, the government of the United States seems more optimistic about the economy than its citizens do, the mortgage markets’ reaction to Bernanke’s suggestion of tapering the bond program is clear proof of that.
It’s also clear that some officials of the Fed, including Bullard, want to see inflation go up before enacting Bernanke’s suggestion. The best way for that to happen is for consumer spending to rise and that is unlikely as long as large numbers of people are unemployed or under-employed and worried about if they will be able to retire comfortably. As you can see, the whole picture is an interrelated economic puzzle with pieces that need to be put together. And whether or not the Federal Reserve starts to cut back on their bond purchases is only one part of the puzzle.
With all the things that need to happen in order for the Federal Reserve to responsibly begin bringing an end to its quantitative easing, it is highly unlikely that they will make any drastic moves any time soon. There are several positive signs that the economy is moving in the right direction, but many top economists feel that it still has a long way to go before the country reaches pre-recession fiscal health. It’s fairly safe to say, that for now, the bond purchase program will remain in place as it seems to be the impetus that has been spurring recent economic growth.
About the Author:
Tony Standin is a personal finance specialist with a passion for helping others understand money, the economy, and the way inflation impacts our lives.
See Also:
- How Have Inflation Indexed Bonds Really Performed?
- What is Deflation?
- What is Quantitative Easing?
- What is the Real Definition of Inflation?
- Cost of Living
- Disinflation – What is it?
- What is the Phillips Curve?
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