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Fed action may hurt more than help

By Greg McBride, CFA · Bankrate.com
Thursday, October 28, 2010
Posted: 12 pm ET

The Federal Open Market Committee, which meets Nov. 2-3, is all but certain to announce renewed measures intended to boost the economy. Specifically, the Fed will engage in another round of bond-buying, snapping up government debt with newly created money. It is hardly a secret this is coming; for those of you too consumed by "Dancing with the Stars,"  Bernanke and his colleagues have been telegraphing it for months. The only question is the magnitude of the effort -- how much and over what period of time?

The Fed's goal is that this step will further reduce interest rates and create incentive to borrow, spend and energize economic recovery. But much of the effects have already been priced in, with the 10-year Treasury yield falling from 3 percent in late July to 2.41 percent by early October. In recent days, investors have been tempering their expectations in the event the Fed takes a more cautious approach, with the 10-year Treasury yield having backed up from 2.5 percent on Oct. 19 to 2.75 percent as of Oct. 27.

So will it work?

This latest go-round won't single-handedly revive the economy any more than the previous version did. And it may not even serve to drive rates lower like the earlier $1.75 trillion government and mortgage-backed debt program did, particularly if the size of the Fed's efforts are deemed to be too modest.

Perhaps the best case is that it keeps a lid on rates, but if so, it won't do much more than serve as a symbolic gesture that "at least the Fed did something." Whether the Fed successfully drives rates lower or just keeps them from rising, this doesn't have the makings of a surge in economic activity. Know any borrowers holding out because rates just aren't low enough?

You might wonder why even bother with it at all. Several years prior to becoming Fed Chairman, Ben Bernanke had scolded the Japanese on their lackadaisical approach to their own deflationary episode. So now Bernanke has to put his money -- make that our money -- where his mouth is.

All this could do more harm than good if it fuels expectations of higher inflation down the road, resulting in a rise in long-term interest rates rather than a decline. Inflation hurts long-term rates the most, and the express goal of the Fed is to create some inflation as a way to avoid deflation.

This also hurts savers in two ways. It keeps rates on income-producing investments such as money markets, savings accounts, certificates of deposit and bonds at ultra-low levels for some time to come. And if inflation is the end result, who does that hurt the most? Those very fixed income investors.

In an effort to boost the economy, the Fed is poised to take a step that has questionable effectiveness. It continues to throw savers under the bus and poses a risk of future inflation that hurts everyone, but savers disproportionately.

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10 Comments
Wayne
November 03, 2010 at 7:54 pm

I am a senior and on a fixed income. Looks like I won't be buying a new car.

LOU
October 30, 2010 at 8:47 am

Politicians will simply, [all too simply] do nothing but SPEND
the more you give them. Their motto: "WHAT?... WE STILL HAVE CHECKS! What do you mean there is no money? Let's RAISE TAXES" !
"Trickle down theory" from politicians to idividuals: "What?...
nothing from nothing REALLY equals NOTHING"? Let'$ CREATE A WAR !
That will keep the econmy going. Gotta' make 'em weapon$! Keep those factories pumping out 'something'...

Joey D
October 30, 2010 at 7:43 am

Well said, "the FED continues to throw savers under the bus". This is penalizing the very folks who are doing the right thing and have been prudent in their retirement goals - the savers. Savers are the bedrock of the economy - not the problem. The economy is being balanced upon the savers back. Is this fair? Absolutely not!

Jun
October 29, 2010 at 6:28 pm

The FED should tap government mortgage lending arm to lend to more qualified borrowers to refinance their homes up to 200% of its current value. This will definetely boost the economy and stir up consumer spending.

rod
October 29, 2010 at 3:29 pm

Oh no the government debt is growing out of proportion to the gdp, which is stagnant! Better deflate the value of money by printing away the debt. All that paper and all your hard earned savings worth less and less.

Donald Hawley
October 29, 2010 at 11:39 am

Where's the Tea Party people? Those of us who have saved money all our lives are being taxed for the bail out of wall street and the banks, plus no return on our savings to pay for poor management of the economy. Retired people have been told by financial advisers after a certain age to be in fixed income products, now people are being forced into risky situations. The best thing to have happen to this country is eliminate the federal reserve and crack down on wall street. I guess we will continue to be double taxed no matter who is in office.