So, we have all heard about the looming fiscal cliff at the beginning of January. It has been hotly discussed and debated on many fronts and the rhetoric of the politicians have controlled the direction of the financial markets. The Fed has assured that there will be more stimulus through buying of long-term treasuries and selling of short-term treasury bonds.
This just means that the Fed will, in effect, attempt to drive the interest rates for mortgages down and drive short-term interest rates up. Thus, in theory, stimulating the economy because one can earn more in the short-term with higher interest rates, right? Right. Now here in lies the problem...banks are not so willing to lend as the Fed would like and thus stunting the growth - or stimulus - for the economy. Banks are still incurring the consequences of the downturn of the mortgage industry in 2007. What to do? Refinance your mortgage. Those who refinance their mortgage will drive the interest rates back up for mortgage loans. This is also a hard line to walk, though. If mortgage rates go up consumers will be less willing to buy...but...banks will be more willing to lend so long as underwriting stays solid - which it has seemed to do for the most part as of late. There is still a long way to go in the recovery but there are signs of life...not enough but some.
The Fed also announced that it will tie the stimulus programs (previously mentioned) to actual targets in the unemployment rate and inflation rate. 6.5% and 2.5% respectively. In essence, the Fed is trying to instill more confidence in the market by giving exact targets. Will this work? Perhaps, but any new approach seems to initially instill confidence in the market. I wouldn't suggest that the Fed is going to stick to this curriculum because the employment rate dropped just this month two tenths to 7.7%. However, over 300,000 dropped out of the labor force. I'm sure it's just a coincidence, though...
The bottom line...the Fed is trying to stick to its almost impossible dual mandate of low unemployment and steady inflation. While this is commendable, it's not realistic to think a single entity can truly gauge what the economy needs. The economy is too complex. The Fed does have an effect on the system, but it is only part of that system and in many cases its probably better that the Fed listen rather than speak.
