The two presidential candidates have been doing a lot of talking about the economy as they crisscross the country promoting their agendas. Congressional candidates have also taken to the podium to talk about how they want to lower the unemployment rate as they campaign.
But there’s another government entity that isn’t campaigning, doesn’t get voted in or out of office, and yet it has enormous control over our economy.
It’s the Federal Reserve, and it just did the equivalent on September 13th of passing unprecedented legislation to give the economy a boost. It’s called QE3, and while its ultimate goal to spur employment could take a while to manifest, you might be seeing the effect on your wallet very soon.
Read on to find out how it works, what the risks are, and how it will impact your bottom line.
All About the Federal Reserve
To understand what QE3 is, you’ll first need a little background. The Fed, as it is called, is the central bank of the U.S., and is tasked with keeping the economy running smoothly. The people running the Fed are economists, professors, lawyers and bankers–basically, highly educated men and women who know the U.S. financial and legal system inside and out. It’s headed by the chairman, Ben Bernanke.
When the economy is sluggish, the Fed has several ways to inject money into the economy. One way, called quantitative easing, is for the Fed to buy bonds, treasury bills or other securities. Quantitative easing injects money into the economy, because the Fed is using money that wasn’t yet in circulation to pay for those assets. That is what the Fed is doing now, and it’s doing it in a big way.
Third Time’s the Charm?
The Fed has already engaged in quantitative easing twice to help kickstart the economy, in purchases worth $2.3 trillion (that’s $2.3 trillion in new money circulating in our economy), but so far the recovery has been anemic. So the Fed is trying again in what everyone is calling QE3.
Chairman Bernanke announced on the 13th that the Fed will buy $40 billion of mortgage-backed securities from Fannie Mae and Freddie Mac … each month. And that’s what makes this QE so special: The Fed won’t stop buying these assets until the unemployment rate drops below 7.5% or inflation gets too high. (More on that below.)
We don’t want to bore you with the details of how it works, but suffice to say, by choosing to buy assets that are basically bundles of mortgages, it’s hoping to lower mortgage rates so that more Americans can buy homes. Quantitative easing can also boost the stock market and help businesses afford to hire more people. That’s the hope, anyway.
If you’re a deficit hawk, don’t panic. This $40 billion a month is not taxpayer money. The Fed is actually creating money through its policies. It’s not literally printing dollar bills, but that’s basically what it amounts to.
How Could QE3 Help You?
The main goal of QE3–bringing down the unemployment rate–won’t be visible for some time. The effect of the buying of assets has to work its way through the economic machine before it spits out jobs on the other end. But there are preliminary effects, according to the Washington Post:
1. Inflation could rise.
Pumping money into the economy has historically had the effect of increasing the prices of goods, because people have more money to spend. So, the biggest risk with this move is that inflation could rise to painful levels. And the worst-case scenario is that QE3 doesn’t boost the economy at all, but only leads to high inflation. That’s what economists called “stagflation” and it led to a lot of pain in the ’70s. Imagine prices going up on everything, while more and more people can’t find jobs. (Learn more about how inflation works.)
Right now, inflation is pretty low, at about 1.7% It’s expected to rise to 2.17%.
Conclusion: You could be paying more for everything from gas to bread to clothing.
2. Interest rates on your savings and checking accounts will stay low.
Checking account returns are pretty much nonexistent. And savings accounts aren’t much better. You can only get interest rates of about 1% at the very best. That won’t change with QE3, since interest rates across the board will drop.
Conclusion: You will continue to earn almost no money on your bank accounts.
3. The stock market could rise.
Since the announcement, the stock market has gone up, but it’s not clear how much of that is attributable to QE3, or just world economic events, like the European Union working to shore up the Euro. However, Fed Chairman Bernanke took some credit for the stock market’s rally over the past few years, attributing it to the first two QEs. If QE3 works just as well, we could see higher stock prices.
Conclusion: If you have money to invest (or money already invested), you might see your wealth grow. (And you can get started with investing with this guide.)
4. Your mortgage rates could drop.
It’s been two weeks since the Fed announced its new initiative. Despite the promises, so far, interest rates on mortgages haven’t budged at all. This might be because banks are afraid that if they drop interest rates too much, they would be overwhelmed by applications to refinance. But interest rates might go down gradually in the coming months as banks work through the backlog of refinancing applications and have more room for new refinancing and new mortgages. Still, banks are skittish about lending to anyone with less than stellar credit, no matter what the offered interest rate.
Conclusion: If you have good credit and want to buy a home or refinance yours, you could benefit.
5. The unemployment rate could go down.
The end goal of QE3 is to lower unemployment by creating better business conditions that will encourage companies to hire. However, because more hiring by businesses depends on the stock market going up, interest rates going down and the housing market improving, we might not see unemployment drop right away, if it does at all.
Conclusion: If everything goes according to plan, you could find it easier to find a new job or negotiate a raise.
As you can see, in the short term QE3 might only benefit those who are already wealthy and can afford to invest and own homes. If businesses do eventually hire, though, everyone will benefit.
What will actually happen is a topic of fierce debate. The economy contains many confounding factors: corporate profits, how much banks actually decide to lend and the value of the dollar compared to other world currencies, among many other things. Even the former Fed Chairman Volcker has indicated he doesn’t agree with Bernanke’s bold move.
But they say that economists are less accurate than even weather forecasters. So on this, it looks like we’ll just have to wait and see.