NEW YORK (MainStreet) Today Chair of the Federal Reserve Janet Yellen gave a speech at the 2014 National Interagency Community Reinvestment Conference in Chicago. Monetary policy speeches may seem distant from the daily grind of life on Main Street; however, the actions of the Fed directly impact each one of us.
In fact, Yellen discussed her support for a continuation of the Fed's support for the U.S. economy in the aftermath of the Great Recession in order to alleviate the financial hardships faced by the common man on Main Street -- unemployment, mounting debt, diminished savings. Yellen said there are real people behind gloomy statistics and that the Fed's has the goal "to help Main Street, not Wall Street."
To parse some of Yellen's plans, Jerry Klein, managing director of Treasury Partners at HighTower, gave useful insight to decoding some of the complicated economic mechanics for those of us on Main Street.
What exactly does it mean to say that the Fed is "printing money"?
Jerry Klein: The Fed has expanded its balance sheet from about $500 billion pre-crisis to about $4 trillion. They have purchased primarily Treasuries and mortgage-backed securities. By purchasing the securities in exchange for dollars, they injected more cash into the U.S. financial system.
Why was it necessary?
JK: The expansion of the Fed's balance sheet was necessary to lower the borrowing cost of money and make it more accessible. Both of these are designed to stimulate economic activity. Since 2009, the Fed has initiated two more rounds of quantitative easing, and the "operation twist" program to bring down the yields on longer-term rates. Interest rates have stayed low and equity markets have risen.
How does it impact average people?
JK: Lower borrowing costs have helped the average person. However, it is unclear if these programs have broadly helped the average person. Certainly risky asset prices have jumped; however, the average person does not own much equity outside of their 401(k). The theory is that higher equity prices will create a wealth effect, which will increase spending and confidence that will trickle down to the real economy and help the average person.
Why is the Fed printing money?
JK: When the Fed purchases securities on the open market, they create new dollars to use in the transaction. These dollars are injected into the financial system, thus expanding the supply of money and making it more available. Of course, this is all done electronically, but the result is the same as it would be if the Federal Reserve were to ramp up the printing of paper banknotes. The purpose of the Quantitative Easing was to lower Treasury rates, which would result in lower corporate and mortgage borrowing ratings. But, it also served to push investors to move out of low-yielding riskless Treasury securities and into more risky assets like equities and high-yield bonds. We have seen risk assets benefit over the past few years.
Is the economy better off now than it was ten years ago?
JK: The economy has pulled out of a deep, disruptive, wide-ranging economic downturn. The U.S. economy is larger than it was ten years ago and many excesses have been wrung out of the financial system. Banks are healthier and transparency has increased. However, the unemployment rate is also higher than it was ten years ago, and studies suggest that average wages are basically flat net of inflation.
What has this done to the bond market and our retirement system?
JK: The Fed's Quantitative Easing programs have kept interest rates low. This has incentivized companies to borrow but at the same time it has undeniably penalized savers by keeping rates low. Pension plans that had a higher exposure to equities over the last couple of years have benefited from the gains in the market, and many are in a healthier state than they were three to four years ago.
Any additional comments?
The Fed is now tapering its latest bond buying program, and investors are beginning to focus on the eventual timing of when the Fed will begin to raise short term interest rates. The Fed's programs may have reduced market volatility over the past five years. As these programs are removed, we would not be surprised to see some increase in volatility, and testing of investor convictions.
--Written by Leigh Held for MainStreet