The End of the Easy Money Romance
'Tis the season for summer flings, but even the happiest romances have to end. And this summer, the U.S. economy is experiencing the first bitter throes of a breakup with the Federal Reserve's easy money policy.
Recent talk about the impending end to quantitative easing marks the end of an era characterized by soaring stock markets and record-low mortgages and auto loans. The economic conditions the nation has enjoyed under the Fed's seductive monetary policy have already started to fade, and many Americans may never again see a 3.3 percent mortgage rate or stocks on extended, relentless upward trajectories.
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Already the low-interest love affair was ending when bond yields and mortgage rates started creeping upward earlier this year from historic lows. And then in June Ben Bernanke sent the rates spiking.
"If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year," Bernanke said at the conclusion of the Fed's June meeting, speaking about the so-called "tapering" of the central bank's $85-billion-a-month asset purchase program dubbed QE3. That statement helped spark the largest one-day stock market drop in 2013, sending the Dow Jones Industrial Average plummeting by more than 350 points the next day.
Which is not to say that stock markets don't still swoon over Bernanke's every word; the Fed chair has subsequently reassured markets in several public appearances, and stocks have perked up again. The Dow Jones rallied Thursday after Bernanke's semiannual Humphrey-Hawkins testimony to the Senate, in which he reiterated that the Fed would not pull back on stimulus until the economy is on more steady footing.
The nation's relationship with easing has changed drastically over time. The policy at first was a rescue operation for an economy in crisis, with a $1.75 trillion infusion of liquidity delivered in late 2008 in response to frozen credit markets. The second round of $600 billion came in November 2010, amid what the Fed's interest rate-setting committee called a "disappointingly slow" economic recovery, including unemployment stuck at nearly 10 percent. Round three began in September 2012 and consisted of $40 billion in monthly purchases, a total that in December increased to $85 billion. The Fed explained that it feared economic growth wouldn't boost job creation without its assistance.
Many credit the first round of easing with bringing the economy back from the brink, and some believe the policies have continued to boost housing markets and fuel a slow recovery.
[ALSO: Dow Slides More Than 350 Points Day After Fed Meeting]
Of course no one thought the honeymoon could last forever. Even those who did not worry that easing would spark hyperinflation knew that the Fed couldn't balloon its balance sheet forever. All signs point to the Fed letting everyone down easy; cutting easing off all at once could send bond yields spiking and stock markets plummeting.
"I think the Fed is going to try to make this a very gradual process. It isn't like they're flipping a switch and saying we're going from lots of liquidity to no liquidity," says Kathy Jones, vice president and fixed income strategist at the Schwab Center for Financial Research. The Fed will likely taper off its monthly purchases and then slowly eliminate assets from its balance sheet.
One other reason the fling is over: a key feature of monetary stimulus is that the flame dies out eventually.
"If you do more and more rounds of this, it's likely it becomes less potent. And as you try to do more, the potential costs may be more likely to outweigh the potential benefits," says Randall Kroszner, a former member of the Fed's Board of Governors and a professor of economics at the University of Chicago Booth School of Business.
Plenty of economists have agreed that each new round of easing comes with diminishing returns. There are those who believe easing has already stopped being beneficial. And Bernanke, its chief architect, will likely be leaving the Fed anyway when his current term ends next year.
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"I think there is a question of how much effect this is actually having in terms of the economy anyway," says Jones. And of course, there are the jilted bystanders, including seniors living on fixed incomes that have wilted along with falling interest rates on bonds, CDs and savings accounts.
For those who will dearly miss QE3 when it's gone, there is always a chance it could come back someday. Now that the unconventional policy has been used by several of the world's major central banks, it may have entered the monetary policy mainstream.
"I think the tool kit of central banks around the world has been expanded," says Kroszner.
Not that the U.S. can expect to see a new round of easing anytime soon. Easing makes the most sense when the federal funds rate, the rate at which banks short on reserves can borrow from other banks, has already been pushed down to zero, meaning it could take another crisis to inspire massive, repeated rounds of quantitative easing again. And with any luck, crises like the Great Recession are once-in-a-lifetime affairs.
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