Back to the Future?

What does the Fed’s decision mean?

The Federal Reserve announced that they intend to purchase $600 billion in Treasury Notes over the next 8 months. They expect that this will lower interest rates and encourage banks to lend, consumers to borrow, and homeowners to refinance, helping the economy expand fast enough to bring down unemployment

Will it work? In theory, it should. Lower rates encourage consumption, for all the cost to savers. What’s more, adding money to the economy this way should depress the dollar and add to the inflation rate. This is considered a good thing by many economists. Higher inflation means that money on the sidelines needs to be put to work or it will lose its value by just sitting around.

But this is madness. Increasing inflation in the short-run will only add jobs in the short-run. Once people get used to higher inflation, workers will demand higher wages in spite of the high unemployment rate. This will hurt corporate profitability and lead to layoffs and fewer jobs in the long-run.

This was the “stagflation” of the ‘70s, and it was caused, in part, by the Fed purchasing bonds. There is no free lunch. Higher inflation now will be paid for by less hiring later.

Some have said Tuesday’s election is taking our politics back to the ‘90s. Let’s hope monetary policy doesn’t lead our economy back to the ‘70s.

Douglas R. Tengdin, CFA
Chief Investment Officer
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