Yesterday, the U.S. central bank ended the quantitative easing programme. It has been the largest economic stimulus programme in history and the Federal Reserve’s most powerful tool over the past few years to spur economic recovery in the U.S.
After the financial crisis hit in 2008, the Federal Reserve cut interest rates to abysmally low levels--practically 0%-- in a bid to stimulate the economy. But that was not sufficient. So the central bank resorted to an unconventional monetary tool known as Quantitative Easing, or QE. This meant that the Federal Reserve would purchase bonds - a mixture of government debt or U.S. Treasury notes and mortgage-backed securities. In this way, cash is pumped into the system.
From where does the Fed get the money? Like all central banks, it has the ability to simply create it. These asset purchases are done by the trading desk at the New York Federal Reserve Bank.
The Federal Reserve has engaged in three rounds of QE: 2010, 2011 and QE3 has been ongoing since 2012. It peaked at $85 billion per month and then the tapering began. Tapering is simply the process by which the Federal Reserve scaled back its purchases -- a gradual phasing out of the bond-buying programme.
Yesterday, the Federal Reserve may announce that it will cease the purchases altogether.
This comes when the global economy finds itself in a predicament of sorts. Europe may be falling back into recession and the global economic outlook has turned gloomier with the International Monetary Fund forecasting mediocre growth.
What is of more significance is the direction of interest rates; the last time the Federal Reserve raised rates was in 2006. Since December 2008, rates have been held near zero.
Last month, Bloomberg reported that the Federal Reserve stated that interest rates would be near zero for a “considerable time” because the labour market is yet to recover and inflation is running below its desired level. But what comprises “considerable time”?
Any decision by the Federal Reserve to raise rates will have implications for economies like India, as it could lead to capital outflows from emerging markets.
RBI Governor Raghuram Rajan has been publicly stating that he is not too concerned and after an initial bout of volatility, there will be differentiation and investors may consider India a good place to leave their money. He believes that India is better prepared to handle the impact of an interest rate hike in the U.S. as foreign funds are less likely to desert the country due to signs of an upturn in economic growth.
Let’s wait and watch.
