Simple Economics: the US way

On the last once-in-a-lifetime date of this century, the US Federal Reserve chairman Ben Bernanke (BB) announced a decision to buy additional $45 billion a month of long-term securities along with $40 billion a month of mortgage backed securities – widely referred to as QE4. Yes, its $85 billion a month of buying securities that BB was talking about!!

The trigger point: Post the economic crisis in 2008-09, the Fed, to support a stronger economic recovery, took some bold steps to loosen monetary policy and increase demand. It decided to keep interest rates at ultra low levels and begin a program of bond buying to inject money into the economy to boost nominal spending. This helps because buying long-term securities pushes up the asset prices and lowers yields, thus lowering the borrowing costs for the firms.

In order to stimulate borrowings and create jobs in the economy, BB promised himself and to the world to keep the rates low and continue spending until the unemployment rate falls below 6.5%.

But looks like BB totally ignored the impact of this program on other important economic factors!!! Won’t keeping interest rates low and infusing $85 billion every month push up the inflation in the medium to long term? It’s a concern because, after all, high inflation rate doesn’t support economic growth.

Now, let’s go back to 2011 when the US Congress agreed to the Budget Control Act 2011 in exchange of raising the debt limit by $2.1 trillion. The BCA 2011 was introduced to reduce the deficit of the country by $1.2 trillion by the end of 2012. However, there was this condition that if the government is not able to meet this target, spending cuts in defense and other discretionary expenditures will automatically trigger at the start of 2013. That’s exactly what happened on the 1^st of March this year!! This is referred to as the ‘sequestration effect’ which triggered automatic spending cuts of $85 billion over the remaining seven months of this fiscal year and will continue to cut $1.2 trillion every year till 2021. As one would easily interpret, the underlying aim here is to reduce the fiscal deficit of the country by cutting on expenditures, drastically.

An analysis, however, says that this automatic spending cuts is expected to put 2.14 million American jobs at risk pushing the unemployment rate to above 9% (current rate is 7.6%). It is also expected to push the US economy towards recession.

This leads to another argument: Won’t the (desired) impact of spending $85 billion per month be set off against the (undesired) impact of automatic spending cuts due to the sequestration effect? What about BB’s dream to reduce unemployment rate and boost economic growth? Pchch… wondering when will that turn into reality?

The current situation of the US economy reminds me of the 2008-09 recession. The only reason why we saw the recession of 2008-09 was that money was made available easily, at cheap rates. The current economic situation resembles very much to the situation of 2008-09. Money is available at cheap rates, housing prices are rising again, US stock markets have hit an all time high breaking 16 years record and there is political instability too.

Wondering over where’s the US economy going again? Well, we can only wait and watch and hope for the best!! *fingers crossed*