Currently, the Federal Reserve buys $85 billion in mortgage-backed securities and treasuries to stimulate the economy and keep interest rates low. With Fed chairman Ben Bernanke’s impending retirement within the year, many are wondering when the Fed will taper off their economic support. Many thought the announcement was going to come at their most recent Fed minutes, but they remained silent on the issue, ironically putting the market in a small panic.
So will the Fed taper the economic stimulus they have? Only time will tell, but there are strong arguments for either case.
Why the Fed Should Taper
There have been strong signs over the past few months that show the American economy is improving. The U.S. Gross Domestic Product (GDP) increased by 2.5% this quarter, marking the second straight economic quarter of growth. This is great news considering the expected growth rate was 1.7% and then 2.1%. This has been credited to a stronger balance in international trade (more exports than imports) and rising commodity prices are a good sign as well. Indicators also show that even if personal income and spending reports are weak, (which they’re expected to be) it likely won’t change the outcome.
Why the Fed Shouldn’t Taper
Despite the GDP improving, consumer spending only increased by 0.1% the last quarter, and big items like cars had the biggest decline in sales. There are plenty of issues like this that could amount to the Fed waiting on their taper: international markets (like India) are looking shaky; unemployment dropped 0.2% in July, due to people leaving the market, an increase in part time jobs and a decrease in average income. The most noticeable objection is rising mortgage rates. While rates are still historically low, Yahoo! Finance points out rates have jumped a full percentage point since May 22. Tapering now could shoot rates higher.
It’s a tough decision with compelling arguments on both sides. Is it a better idea to wean the economy off the stimulus the Fed has provided while things are on the upswing, or is it wishful thinking to assume we’re out of the woods? This’ll affect the country in major ways, but especially if mortgage rates make a bold turn up or down. CNN Money wrote on an academic essay by Arvind Krishnamurthy and Annette Vissing-Jorgensen that presents a three-step plan on how the Fed can taper without harming the housing market, but there’s no guarantee they’ll implement it.
What are your thoughts? Should the Fed start the taper or hold off?