The Federal Reserve’s Expansionary Gamble

In a risky effort to boost lending, America’s central bank is injecting billions of dollars into the financial market.

The Federal Reserve unveiled a controversial measure on Wednesday to help the still fragile American economy recover.

With a plan to buy $600 billion worth of United States Treasury bonds over the next eight months, the central bank is hoping to boost liquidity in the financial market and encourage banks to ease their lending to private businesses.

The Fed’s move is controversial but actually the second of its kind since the recession began. Between December 2008 and March of this year, the Federal Reserve financed as much as $1.75 trillion in sovereign debt. Economists are divided on the effectiveness of the program.

By buying additional Treasury bonds in the months ahead, the Fed aims to keep long-term interest rates low, hoping that it will prompt businesses to invest and consumers to spend more. The central bank has few other options at its disposal. Short term interest rates are near zero while additional government stimulus is opposed by Republicans in Congress who recently won a majority in its lower chamber.

Despite previous bond purchase programs and multibillion dollar stimulus measures on the part of the federal government, America’s economy remains mired in recession. Unemployment still hovers around 10 percent while some of the country’s antiquated industries are struggling to compete with companies in China, Germany and low wage countries in East and South Asia. Inflation rates have remained low at 1.2 percent but may well increase as a result of the Federal Reserve’s expansionary policy.

Underlying the disappointing job creation and investment rates in the United States is not so much a lack of liquidity rather a persistent lack of confidence in the ability of the American economy to recover. Uncertainty about the Obama Administration’s apparent anti-business agenda and the imminent effects of the Democrats’ financial and health-care reform bills are discouraging companies, large and small, from expanding and hiring at home.

The Fed’s decision to effectively inject another $600 billion in the American economy has the added disadvantage of further inflaming what has been dubbed the currency war. Several countries, China foremost among them, have artificially undervalued their currencies in order to enhance exports. China’s leadership fears that an appreciation of the renminbi will spell disaster for the country’s economic stability whereas American lawmakers have complained that China is keeping its exchange rate low at the expense of their manufacturers.

The increase in liquidity that will result from the Fed’s latest policy will probably make the dollar cheaper. That could benefit American exporters but it will hurt the average consumer. The United States import far more than they export and many of those imported goods come from China. If the dollar is cheaper, importing from China becomes more expensive.

Around the world countries that have recovered far more impressively from the crisis than America has are tightening their money supplies. The central banks of Australia and India raised interest rates this week. China did so last month and it is slowly allowing the renminbi to appreciate in order to temper exuberant growth rates at home. In Frankfurt, the European Central Bank has been the most vocal proponent of fiscal restraint, recommending austerity and spending cuts instead of stimulus.

The Bank of Japan, by contrast, is following the American lead, in part because it may want to counteract any boost to the yen as a result of the Fed’s announcement and because it intends to drive down its own exchange rate compared to the Chinese.

Leave a reply