Federal Reserve Chairperson, Janet Yellen, today announced that Fed will continue its low interest rate policy for some time into the future. Many had expected Yellen to indicate that with the improving economy, the Fed would begin a slow rise in interest rates. Yellen’s commitment of more gin in the punch bowl had an immediate effect with the Dow Jones Industrial Average, S&P 500, and the UK’s flagship FTSE 100 all hitting record highs.
Generally, rising stock markets are positive signs if the rise is based on appropriate economic fundamentals. The lengthy drive-up of equity values are instead being driven by the Fed’s low interest rates and Quantitative Easing. This is problematic at various levels. First, should there be an economic slowdown, as there inevitably will, the Fed would have no ammo left to juice up the economy. In addition, when interest rates eventually rise, overvalued equities will show a rapid decline in value causing significant economic pain.
Perhaps the most problematic aspect of the Federal Reserve’s low interest rate policies is who benefits from them. While some on mainstream benefit as equity values rise, especially in 401(k) plans, the greatest benefit goes to the highest income brackets, the people who have the most to invest. This has led to the large increase in the income disparity in the United States. The Fed’s continuation of its policies will further increase the disparity.
Finally, the Fed’s low interest rate policies have cajoled investors into higher risk investments in search of yield. This places further upward pressure on equity values as the bubble builds and guarantees that the next downturn will be exasperated by these interventionist policies.
For many months government publish statistics has shown a significantly improving economy. In addition, by the classical definition, the recession ended years ago. These two items seem in conflict with Janet Yellen’s announcement today that the economy is still fragile. Either the government’s published figures or Yellen’s comments of earlier today relating to the economy need to be questioned.