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Comment by fbuilesv | Hacker News Reader

Can someone with knowledge of economy explain what's going on here and how does this affect me as an individual or as a company?

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Finance geek here. The whole point of this is to raise inflation. Not by a lot, but by a little. The market is currently forcasting ~2.5% inflation looking forward and this won't likely push that expectation above 3-3.5%.

The reason for this is because the fed's 'dual mandate' to keep inflation low and unemployment low. The big theory behind this is the so-called Phillips Curve, which states that there's an inverse relationship between unemployment and inflation. The reasoning here is threefold:

1. It's believed that inflation 'lights a fire' under capital (i.e. it's expensive to hold cash), which spurs people to invest, which in turn creates jobs.

2. Wages are sticky -- after losing a job, people tend to be reluctant to take a big pay cut when accepting new job and so tend to wait for something better to come along. Paradoxically, people are more willing to take a REAL pay cut when the NOMINAL pay cut is smaller, as would happen in an inflationary environment (note: there's no change in actual spending power).

3. Higher inflation acts as a transfer to borrowers from lenders. Any debt currently issued before a change in inflation will have been valued in light of lower epected rates of return. A change in inflation expectations effectively decreases the debt burden on any debt held before the change. This improves firm's balance sheets by decreasing the value of debt on their balance sheets, making them more able to invest.

As an individual, there's not much to guard against here. We should expect this to have a slightly positive impact on jobs and asset prices. We should also expect inflation to run a little higher, but there's little risk of any sort of run-away, or "hyper," inflation because of this -- the fed can stop inflation as easily as it can start it by

[Edit: Corrected Taylor Rule to Phillips Curve]

I think you mean the Phillips curve instead of the Taylor Rule here - but excellent explanation.

Thanks, you're right and I changed it above. For those curious, the Taylor Rule is more accurately a method for optimizing along the Phillips Curve.

Do you know of any quality finance forums or sites? Perhaps something like HN but for finance? I'm looking for a place to read up more and learn. Thx

I don't know a great all purpose finance board. Unfortunately, there's a lot of really terrible advice at most public finance and investing forums and as a beginner it can be really hard to tell who's running on ideology and who's actually done their homework.

The most sophisticated community I know of is the board at Wilmott.com. And I saw that someone tried a nice HN clone at quantly.com, but it sadly never took off.

My personal approach is to build out (and regularly cull) an RSS folder with financial analysis, quant methods and economics blogs. The newsletter from AbnormalReturns.com is a great starting point. Also, ritholtz.com, A Dash of Insight (http://oldprof.typepad.com/) and marginalrevolution.com might be good starters.

http://www.wilmott.com/index.cfm?NoCookies=Yes&forumid=1

I'm guessing you're looking for something punchier than the Wikipedia page.

But may I recommend the EconTalk podcast. http://www.econtalk.org/archives.html#category

In particular, Barofsky on Bailouts (http://www.econtalk.org/archives/2012/09/barofsky_on_bai.htm...), Johnson on the Financial Crisis (http://www.econtalk.org/archives/2011/11/simon_johnson_o.htm...), and Wapshot on Keynes and Hayek (http://www.econtalk.org/archives/2011/10/wapshott_on_key.htm...).

Hell, the entire EconTalk podcast series is full of so much braininess.

This is a pretty complex subject and there is more to it than just printing money and buying up T-Bills.

My opinion on the matter is that ultimately this is a maneuver to devalue the dollar. Historically, there are two ways out of massive sovereign debt: 1) default, and 2) print as much currency as you can so that you can easily pay your debts with worthless paper (or coin as it has been historically).

This is a method under the guise of helping the housing market to inject billions (if not trillions) of extra liquidity. Eventually, that leads to higher inflation, which devalues the currency.

I would like to hear arguments _against_ this view, because this is what seems most likely to me as well. But it is certainly not what all the markets are expecting: The bond market is eating up all long-term bonds issued by any economically stable state under the "flight to safety" phenomenon. At very low interest rates.

So any good arguments against the inflation view (except the obvious: the market is not expecting it) would be welcome.

I tried to explain this in a post a while ago:

http://news.ycombinator.com/item?id=4087686

I'm not an expert but I'll try. The Federal Reserve is buying mortgage backed securities to keep the mortgage interest rates low. Those securities are the way that banks that give you a mortgage raise their money. The federal reserve is also trying to keep longer term interest rates lower by selling short term bonds and using the proceeds to buy long term bonds (operation Twist). The general idea is to spur economic activity by increasing the money supply. ( http://en.wikipedia.org/wiki/Quantitative_easing )

The most significant thing this signals, in my opinion, is the expectation that the economy will continue to do poorly in the short and medium term. People have equated these policies to pushing on a rope, the Fed can lower the rates but it can not force companies to take loans and higher risks.

As an individual you may be able to refinance your debt at a lower rate. As a company you may be able to borrow money at a lower rate. In the real world however (as someone involved in a business who just got a bank loan for 6%) this doesn't always work.

The stock market may go higher because lower rates make bonds a less attractive investment. The only problem is the bond market isn't as impacted because some people feel the Fed will not be able to continue maintaining lower yields due to inflation.

(EDITed with some more thoughts)

I'll add to this.

Edit: consumer-level or corporate level credit won't be any cheaper - only a very specific type of credit, ie mortgages, would become cheaper still.

As you've rightly pointed out, the Fed is targeting mortgage rates, and thus, home affordability. This is to support house prices and encourage construction-based spending in the economy.

House-buying and construction have the biggest multipliers in terms of their knock-on effect on the economy. That's why the recession was so deep - and that's why a recovery can only truly be kick-started by making mortgages affordable.

However, some big downside risks here:

(a) The European crisis, obviously - although the politicians now seem to have come to their senses a little bit.

(b) The credit burden on the US consumer - consumers are still quite leveraged and spending is still financed heavily by credit than by pure income. That will always cause blips to the economy (like oil-price induced inflation) to be magnified and will defeat what the Fed is trying to achieve.

(c) Short-term commodity inflation risks - but given that WTI light crude is almost $20 below Brent crude, there already is a North American supply glut.

Does this mean the Fed owns a bunch of houses around the country? How exactly do they target mortgage rates?

They buy mortgage-backed securities in the secondary markets which, in simple terms, are bonds issued by securitization agencies (well, mostly by Fannie Mae and Freddie Mac in the residential mortgage area) to fund pools that buy and collect individual residential mortgages. The higher prices for MBSes leads to cheaper funding for such pools.

If funding of mortgages is cheaper for banks and agencies, then they become cheaper for the borrowers as well. Even if you aren't buying a new home, you can refinance your existing mortgage at a lower rate.

So the FED is basically printing money and giving it to Fannie Mae and Freddie Mac to lend out as cheap mortgages?

Isn't this what caused the 2008 crisis in the first place?

The Fed is trying to stimulate the economy. The ideas is people and companies should spend money, invest, give loans, etc. The Fed can't force you to spend, but they can raise the inflation rate. Ideally this means you decide to shift from saving to spending and investing and the economy recovers.

The downside is that this hurts savers, particularly small time savers who aren't investor class people. And is still not guaranteed to work. So you get the worst of both worlds, a higher inflation rate and still not enough jobs.

I find it interesting how you judge the inflation rate on a continuum (higher than before, when it was lower), but the jobless rate as a binary (enough/not enough).

For example, I could say that it was the best of both worlds: more jobs, and the inflation rate won't be bad.

I just looked back at the first sentences of that paragraph, and they're just as interesting. Both parts of the observation are binary (hurt/unhurt vs. guaranteed/not guaranteed), but the one that you want to imply is more important, you judge on a positive margin, and the one you want to imply is less important, you judge on a negative margin, i.e. if a "small time saver" loses a single dollar more under Q.E.3 than if it hadn't happened, that "small time saver" was clearly hurt; if there is any confluence of future possibilities that could cause Q.E.3 to not achieve the Fed's goals, it is clearly not guaranteed.

People are so interesting in so few words.

Great analysis, I am indeed biased. But too lazy to describe my bias in details, so I just write with bias.

Basically using more and more extreme measures to keep interest rates down and try to accelerate the recovery.

Step 1, bring short-term rates to zero (end of 2008)

Step 2, (2010) announce that you're going to keep rates near zero for an extended period, and make it increasingly specific (currently through 2015). Since today's 2-year rate is the current 3-month rate compounded with the forward 3-month rates out to 2 years, that has the effect of pushing the yield curve down to near zero out to 2 years.

Step 3, (2011) 'Operation Twist', announce that you're buying long-term bonds and selling short-term bonds. That pushes low low rates even further out the yield curve.

Step 4 (today) buy mortgages via MBS, directly pushing down mortgage rates relative to Treasurys. Means lower rates for borrowers who can qualify for mortgages/refis. Also lowers credit spreads by taking away an option for people who want to get high rates by taking on credit risk such as mortgages/corporates, pushing lower rates up the credit spectrum.

bottom line... low low rates. Europe, China, Japan not doing too well these days, Fed trying desperately to avoid similar fate for US. Generally good for stock markets/startups, if investors can't make high returns in deposits/bonds they're more likely to try to find them in stocks/startups.

Not exactly. Long terms rates have actually risen* from this announcement. The short term effect is, yes, more demand for treasuries which pushes yield down, but the long term effect is higher inflation, which pushes yields up. Following the same reasoning, this is indeed good for stocks, since there's both a liquidity effect (more money that has to go somewhere) and an inflationary effect (larger future cash flows increase present value)

*http://www.treasury.gov/resource-center/data-chart-center/in...

well, sometimes there are second order effects... The Fed is committing to lower rates to boost the economy... traders say, I think they're going to succeed in boosting the economy...that means some rates should go up! Paradoxically, if people decide that the economy is going to do better, and then they invest and spend more and long rates go up, the Fed thinks 'mission accomplished'.

Neverthless, as a first order approximation I would stand by the notion that buying bonds makes their prices go up, rates go down.

But yeah, if the policy is successful it will steepen the yield curve.

Sure. Here's a great video on the subject: http://www.youtube.com/watch?v=PTUY16CkS-k

Downvoting because this isn't so much an explanation of QE as a biased dialog put into cartoon form.

Here's something a little better: http://en.wikipedia.org/wiki/Quantitative_easing

Bernanke is pumping up the stock market to help President Obama get reelected.

</conspiracy-theory>

It's incredibly hard to predict how these massive macro changes affect us on an individual or company level.

If he wanted to do that he would have done it in June or July, not now.

> If he wanted to do that he would have done it in June or July, not now.

Not necessarily. If he'd done it in June/July, we could look at the results, which might not be good.

Doing it now, Obama can continue to argue "things are going to get better real soon now".

Stock market indexes are generally forward-looking. We'll see QE3 "priced into" the market before we see its effects.

> Stock market indexes are generally forward-looking. We'll see QE3 "priced into" the market before we see its effects.

QE3 is pretty much already priced into the market.

However, the stock market won't help Obama. He needs employment.

The median income has gone down more during the "recovery" than it did during the recession. The only reason why unemployment is stable/creeping down is that folks are dropping out of the workforce; workforce participation is dropping.

Heck - compare the number of folks going on disability to the number finding work.

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