The US federal government this month decided against tapering its $85 billion bond buying program. This decision surprised many analyst who had been expecting a reduction in purchase by the US Federal Reserve. The Fed explained that the economy wasn’t moving along as strongly as they hoped to warrant a reduction in asset purchase.
Despite its explanation, I believe the Fed was wrong not to begin tapering its asset purchase program. Since the recession in 2008, it has been buying assets in what is know as Quantitative Easing or QE to increase demand in consumption and the money supply in the economy. QE has worked in helping drive down unemployment and helped the stock market reach new heights. But two worrying issues remain.
The first is Inflation. Increasing the money supply in the economy by printing money artificially increases the prices for goods as people have more money to purchase the same number of goods. Since 2008 the Fed’s balance sheet has more than tripled to $3.6 trillion. This rise in supply of money hasn’t caused major inflation yet but sustaining it only increases the chances of higher inflation in the future.
The second major concern is QE’s long term effect. Like an addict experiencing withdrawal, even the mention of tapering in May caused stock markets to go lower and caused volatility. Although this is unavoidable as market participant start dealing with a lesser role by the Fed in the market, the longer the Fed continues QE, the more painful and volatile the market will be when the Fed eventually begins tapering.