A First Step for the Fed

Announcing yesterday the end of its strategy of massive purchases of Treasury bonds and mortgage-backed securities, the American Federal Reserve has made the first step toward the normalization of its monetary policy. The road will be long.

This program of “quantitative easing” (QE), in its third phase since the financial crisis of 2008, has injected hundreds of billions of dollars into the U.S. economy. Particularly, in buying these bonds and securities, the Fed has lowered interest rates in hopes of encouraging investment.

As soon as the first phase launched in the autumn of 2008, QE had been much debated. After all, it consisted of “printing” money in order to stimulate the economy, a blatant violation of the rules followed by the central banks until that point. Today, the majority of economists estimate that the three phases of the program have contributed to the boost seen by our neighbors to the south. The Canadian economy has benefited from it, as well.

The decision announced yesterday by the American central bank is in itself good news. It shows that, according to the Fed’s leaders, the economic situation in the United States is continuing to improve. The press release emphasizes, among other things, the “solid gains” recorded in employment.

The stock markets have reacted soberly to the news, a calm that settles with the brutal fall provoked by the first sign of a decrease in purchases last year. Since then, the Fed has thoroughly prepared the terrain, and the landing was made softly. But the hardest work remains to be done.

The long-term interest rates remain abnormally low in the United States, Canada and elsewhere in the world. This has some positive effects for borrowers (namely governments), but it hurts retirement plans and people whose savings are entrusted in guaranteed investments rather than in the stock market. The Fed will begin, probably over the course of the next year, to raise the cost of loans once again. In a troubling international situation – stagnation in Europe and weakness in China and other emerging countries – will the American economy be strong enough to withstand this increase?

Another challenge for the Federal Reserve: in buying all of its bonds and securities, it has accumulated in its coffers $4.5 trillion in assets, five times more than what it held before the crisis. One day or another, it will have to recover its money. Again, the maneuver will be tricky. In launching QE in 2008, the Fed entered into uncharted territory. This week, in starting the slow return to a conventional monetary policy, it continues to navigate an unexplored sea.