The Federal Reserve has recently been expanding their balance sheet by approximately $85 billion a month in an effort to stimulate the economy through quantitative easing. There are several proposed channels that this would affect the greater economy, mostly related to what Bernanke and Gertler called the credit channel. The credit channel would presumably return the amount of lending to a normal rate or one that is expansionary. The goal of this credit easing is to aid the economy back to health and keep credit markets functioning at or near some desired level. Several studies that have indicated that interest rates are lower as a result of this credit easing, however the effects on the overall economy are unclear.
Currently, the economy is not visibly strong, and banks like Societe Generale and Bank of America have already trimmed their Q3 and Q4 forecasts for U.S. GDP growth due to the effects of the government shutdown and debt ceiling crisis. Furthermore, Senators Rand Paul and Lindsey Graham have threatened to hold up nominations until they get something more on Benghazi (Graham) or Fed transparency (Paul). If the Fed nomination of Janet Yellen is withheld for a long period of time, it might lead to more market uncertainty.
There is some recent news that certain types of loans have increased in number while also becoming more risky. Commercial mortgage backed securities (related to commercial property) have been increasing in number this year, and Moody’s has recently sounded an alarm on this practice due to weak underwriting (i.e., credit checks and due diligence). The current low interest rate environment is expected to continue for some time (the end of 2014?) and the Fed is expected to continue their current policy of purchasing $85 billion of assets every month until at least March 2014.
Questions you might answer:
- Should the Fed continue their current policy to March 2014 or should they begin tapering sooner? What stories or facts other than the ones mentioned here would indicate a need to adjust their course?
- What do you expect the Federal Reserve to do if inflation expectations were on the rise? What does the Fed actually target these days anyways? What would it take for the Fed to dramatically change course at this time?
- If the goal of Fed policy is to operate through the credit channel, what would indicate that this is working? Many economists have worked on this theoretically, but the empirical evidence is pretty weak. See what you can find that would indicate if this policy is working or not. Would a rise in risky CMBS indicate an effective easing policy or something else?
- What would happen if the nomination of Fed chairwoman Janet Yellen were held up for an extended period. Has this happened in the past with anyone else? Do we have any reason to expect that her nomination will be denied by the Senate?