Easing Of Quantitative Easing

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[I'm starting to see stories about governments in the US and the European Union talking about putting the brakes on quantitative easing (QE). Canada is similarly talking about raising interest rates. I think we'll hear more about this over the next while. This is a pretty good blog entry on the general implications of QE. See: The Fed's US$4.5-trillion question: How to handle the Great Unwind?; Canada's long ride with rock-bottom interest rates appears to be ending; ECB considered abandoning vow to accelerate QE. *RON*]

Patrick Stoy, WilmingtonBiz Insights, 30 June 2017

In a move that signals growing, widespread confidence about the strength of the national economy, the Federal Open Market Committee voted last week to increase the target range for interest rates and to decrease the rate at which it purchases treasuries and mortgage-backed securities.

According to a recent press release from the Fed, the committee will begin reducing the amount of mortgage-backed securities it purchases each month by $4 billion during the latter part of this year.

At the same time, the Fed will also begin slowing down its reinvestment into treasuries by a factor of $6 billion per month. On the surface, this sounds like something that could potentially cause a massive shift in the health of the economy, but it is not quite as impressive once you consider the Fed is currently purchasing approximately $30 billion in mortgage-backed securities per month.

Both numbers, the $4 billion and $6 billion, will increase after three months from the start date of the initial commencement of the easing of the re-investment. For mortgage-backed securities, the Fed is expecting to reduce its reinvestment by an additional $4 billion every three months, until a ceiling of $20 billion has been reached. With treasuries, the Fed is hoping to take an additional $6 billion increment off the table every three months, until a ceiling of $30 billion has been achieved.

This reduction of capital infusions into the smaller lending institutions will continue its downward spiral for a number of years, until the estimated $4.5 trillion the Fed is holding in its virtual coffers is reduced to a smaller amount, probably a little more than $200 billion or so. I say $200 billion because this was the amount the Fed held on its balance sheet prior to the implementation of quantitative easing, and everyone expects them to hold more funds on hand than in the years leading up to the recession, if nothing else than a strategy for minimizing risk.

I say virtual because the necessary assets to purchase the securities never existed in the first place; it was just virtual, cyber-credit created by the Fed to provide the banks with liquidity. This is a prime example of what people mean when they talk about the banks’ ability to simply print more money.

By the way, a trillion is 12 zeros. Also, in case you are one of those people who don’t think about economic policy on a daily basis, quantitative easing occurs when a central bank uses credit to purchase securities through member institutions, in an effort to increase the money supply, add liquidity, spur lending to individuals and small businesses and control inflation.

Quantitative easing was instituted in the U.S. in 2008 to help the banks by taking risky mortgage-backed securities filled with subprime loans off their balance sheets. The intent was to encourage banks to increase lending to individuals and small businesses, to expand the economy, and in many ways, it succeeded.

What does this mean for me? The crux of it is that interest rates are going to begin to climb over the next few years, but for good reasons. Confidence about the economy is high or the Fed would not be considering taking off the training wheels. This means that now is a great time to purchase a home, not only because it is a viable, stable long-term investment, but also because interest rates are going to climb, purchasing power will decline, and the experts at the Fed agree: the future economic outlook is positive.

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