TRAVERSE CITY — My dad often paid me a compliment when I was younger.
Well, sort of.
My father saw little value in idle chit-chat, but he would offer praise by saying I do have “the gift of gab.”
I’ve grown to learn my so-called gift can bring mixed results. In a similar way, incoming Federal Reserve chairwoman Janet Yellen will likely learn a few lessons about the effectiveness of the Fed’s own gift of gab, known as forward guidance.
For over a half decade now the Fed has conducted an experiment. Following their initial success in providing loans to banks, the Fed dove headfirst into an untested policy of quantitative easing that plunged short-term interest rates to almost zero. This controversial policy, known as QE, is the subject of heated debate.
It is now undeniable the Fed wants out of QE. At their December meeting, the Fed blinked yet again — for the third time — by announcing its intention to gradually end QE. They plan to first slow, or taper, then stop purchasing government debt. It begs the question: why stop now with unemployment still too high and inflation still too low?
By the time they end QE, about $4.5 trillion of US government debt will be owned by the Federal Reserve. Like any bank, the Fed earns a spread: the difference in the rate it pays its depositors and the rate it earns on its investments. By holding short-term rates at near zero, almost all of the interest paid to the Fed by the US Treasury passes right on through to its single shareholder, the US Treasury itself. This provides pain-free budget relief by having the left pocket pay the right pocket about $100 billion a year. It’s a circle that comes with risk.