Fed Pledges $1.2 Trillion to Revive the Economy
by Rosanne Lim
As the United States sinks deeper into recession, the Federal Reserve is pulling out all stops to stop to downtrend. According to Mike Larson, a Weis Research consultant:
The Fed is kind of going all in
The $1.2 trillion will be used to lower mortgage rates and other types of debts in order to spur economic activity. The Fed will allocate $300 billion to buy long-term government bonds while it will spend $750 billion in mortgage-backed securities by Fannie Mae and Freddie Mac.
What This Means for the US Economy
Fed Chairman Ben Bernanke the key short-term bank lending rate between zero and 0.25 percent. The record low figure is expected to remain for the rest of the year and for most of next year. Keeping the rates near zero was an expected move. However, the sheer amount that was pledged for the US economy, $1.2 trillion was not expected by economists or investors at all.
The market was thrilled by these developments. The Dow Jones industrial average rose to 1.2 percent to 7,486.58. Broader market indications also showed signs of growth. The price of government bonds likewise skyrocketed. Because a drop in mortgage rates is expected, 10-year Treasury note dropped its years from 3.01 percent to 2.50 percent. Notably, this is the biggest percentage point drop in Treasury note yields since 1981.
Meanwhile, the dollar fell against major currencies mainly because investors are concerned about the long-term effects of this intervention. If the financial market is stabilized because of the Fed’s involvement, recession can end this year. And if the Bernanke’s plan works out, recovery can start in the next year. The Fed had already previously said that it will use all available methods at its disposal to make recovery possible; it is expected that further actions will be utilized in the coming months.
How the Money will be used
In late January, the Fed has said that the “economy continues to contract”. It has revealed that declining equity, the credit crunch, and job losses is stopping consumers from spending”. Previously, the Fed has already hinted that it will spend $300 billion to buy government bonds. The action is initiated to increase Treasury prices and lower their rates. The rates on various types of debts will fall as a result of this development as well.
The $750 billion in mortgage-backed securities that will be bought from Fannie Mae and Freddie Mac is in addition to the $500 billion that was already pledged buy the Fed. In addition, it will also double its debt purchase to $200 billion. It should be noted that since the first program to rescue Fannie and Freddie was revealed last year, mortgage rates have fallen. Expanding the program can reduce rates further.
Where Will the Fed Get All That Money?
Essentially, the Fed will get the money by printing more currency. The Federal Reserve’s intervention to buy debts and lend money has bloated its balance sheet to almost $2 trillion. Just last September, the figure was at $900 billion. Over the next two years, analysts believe that it can swell to as much as $5 trillion. These developments make a lot of people wonder; does the Fed know what it’s doing?
The Fed has stated that it knows the risks of printing more money and leaving interest rates to nearly zero. It said that it also know the risks of bailing out financial institutions. There is a potential that higher inflation will result because of this intervention. In addition, there is the “moral” hazard involved in this move: certain companies may become more reckless after knowing that the government will rescue them.
Despite all these, the Federal Reserve hopes that the $787billion stimulus package, its $1.2 trillion in pledge, and its current monetary policies will be sufficient to revive the economy and end today’s recession. Although the short-term outlook is weak, the Fed anticipates that their actions will help “contribute to a graduate resumption of sustainable economic growth”.
Tags: currency, currency infusion, Economy, stimulus, US Dollar
About the Author - Rosanne Lim
Rosanne started has been in the financial services industry since 2005. She is currently applying her knowledge about banking and finance to the currency industry.
