The Federal Reserve Interest Rate Policy - Jon Song

The Federal Reserve (the Fed) announced yesterday, January 28, 2015, that it would not raise short term interest rates before June.  Currently, real interest rates lie near zero, where they have been since the Fed began quantitative easing as a response to the 2008 financial crisis.  In the statement released yesterday, the Fed announced solid economic and job growth despite recent turmoil in the markets, think oil prices, in its most optimistic report since the recession.  However, inflation remains too low and looks to remain this way, a possible harbinger of an economic contraction if the Fed withdraws its economic stimulants too quickly.

From my point of view, this is a logical decision based on the quantitative easing policy that the Fed has set forth.  However, I am surprised by the effectiveness of the Fed's quantitative easing policy thus far.  The Feds goal from the beginning was to stimulate economic and job growth, and even though it took a few years, unemployment is back down to around five percent.  It may still take a while longer for inflation to bounce back and for the economy to grow at robust enough rates to sustain a hike in interest rates.  This quantitative easing policy has already impressively weathered the tapering and halt of bond purchases.  This pumping of money into the economy has worked well to stimulate job growth, which has caused the Fed to now focus on interest rates to stimulate further economic growth.  The Fed plans on doing this by keeping rates low by continually renewing maturing bonds.  My concern with this entire policy is the the massive balance sheet that the Fed has accumulated.  $4.5 trillion in assets is unprecedented and I believe the Fed will have great difficulty in unwinding this balance sheet.  This could result in the Fed holding onto a massive amount of assets  for decades to come, which, along with the Fed actually selling off the debt it holds, could have unforeseen ripple effects in the global economy.

- Jon Song

http://www.federalreserve.gov/newsevents/press/monetary/20150128a.htm
http://www.nytimes.com/2015/01/29/business/federal-reserve-rate-decision.html?ref=politics&_r=0
http://www.nytimes.com/2014/10/30/business/federal-reserve-janet-yellen-qe-announcement.html?_r=0
http://www.nytimes.com/2014/10/30/upshot/the-fed-has-not-stopped-trying-to-stimulate-the-economy.html?rref=upshot&abt=0002&abg=1&_r=0