The next Federal Open Market Committee (FOMC) meeting is slated for next week. This meeting of some of the biggest big wigs in the Federal Reserve will decide what to do next for the economy. Last month, at a symposium held in Jackson Hole, Wyoming, Fed chair Ben Bernanke essentially played for time. He didn’t announce any new sweeping economic policy measures — but he didn’t close the door on them. Basically, he took a wait and see approach. The members of the FOMC wanted a little time to see what would happen with the economy before deciding what to do next.
Now, as next week draws ever nearer, and as economic data from around the U.S. turn out to be mostly disappointing, some are predicting that the Fed is ready to pull the trigger and institute another round of quantitative easing. Bernanke left the door open for such a move last month, expressing his commitment to taking the steps necessary to stimulate the economy.
So, if we do end up with another round of quantitative easing (another round would be the third, and referred to as QE3), what can you expect?
First Things First: An Overview of Quantitative Easing
When the Fed and other policymakers want to stimulate the economy they usually just lower the Fed Funds rate. This rate is the rate at which banks lend to each other using immediately available funds. Interest rates in general head lower, and the idea is that more borrowing can take place, and help stimulate economic growth. (It is important to note that the Fed doesn’t actually set the rate; it sets the target for the rate, and the actual rate is, theoretically, determined by the markets.)
However, there is only so low you can go with the Fed Fund rate. Right now, the target is set for between 0% and 0.25%. That’s pretty crazy-low. So the FOMC can’t go lower. This is where quantitative easing comes in. In an effort to stimulate the economy, the Fed creates money, essentially out of thin air, to purchase government bonds, and even private assets. The point is to get more money circulating in the system to spur economic growth. QE2 ended this past summer, and some think that QE3 is right around the corner.
What It Means for You
In many cases, quantitative easing can prop up the stock market. It makes borrowing less expensive for companies, and can increase their profits margins/earnings, and that means a boost. Plus, with Treasury rates plunging, and cash yielding very little, many investors decide to look for the greater returns of increased risk.
However, it also means that we are likely to see inflation. An increase in the money supply means an increase in inflation, as the buying power of the dollar is eroded. One of the goals of QE is to encourage inflation, of course, since that indicates economic growth (except in the case of stagflation). However, efforts could backfire and inflation could grow out of control — without the requisite amount of economic growth and income growth to help offset the effects.
For most people, QE3 is likely to mean continued low yields on their cash products, as well as inflation hitting you in the wallet. However, you can offset some of the effects with certain investments. Some believe that now is a great time for dividend stocks, as well as for commodities — especially gold, which is sometimes used as a hedge against inflation.
What do you think? Is QE3 imminent? And what will you do to protect yourself?