Fed Should Keep on With Its Expansionary Policy

Since the beginning of this financial crisis the Federal Reserve has implemented various measures to improve credit availability and fasten the recovery. However, because of the rapid increase in money supply, many investors are beginning to worry about the need to anchor inflation expectation.

Indeed, the scale and the size of monetary stimulus in the United States are unprecedented. Since August 2007, the Fed has lowered its main interest rate by 5 percentage points, bringing the overnight lending between banks nearly to zero. Moreover, the US central bank is expected purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Fed is in the middle of buying up to $300 billion of Treasury securities.  

However, as much effective those measures are supposed to be, the credit availability is still scarce.  For example, small businesses are still struggling to survive. Domestic demand is still weak and banks remain reluctant to lend. Also, the Term Asset-Backed Securities Loan Facility (TALF) program, which aims to stimulate the credit growth is still at its early stage. Furthermore, purchases of  mortgage-backed securities and other longer-term assets by the Fed haven’t helped that much in lowering mortgage rates. The average 30-year rate is now above 5.1 percent. Looking further, it is hard to imagine the consequences of tightening the monetary policy while mortgage delinquencies are still rising. More importantly, rising unemployment is likely to keep consumer demand weak throughout 2010.

Anna Fedec, contact@tradingeconomics.com
7/27/2009 4:05:32 PM