Federal Reserve Policy Implicates Grad Student Decisions
By Arthur Saakian
Quantitative Easing is the Kool-Aid that America is drinking—at least until 2014. Manufactured by the Federal Reserve at the start of the Great Recession in 2008, Quantitative Easing–or QE–is a monetary policy used by the Fed to increase the supply of money in the economy by keeping bank interest rates on loans at or close to zero. Since December 2008, Fed Chairman Ben Bernanke has expressed high hopes that keeping interest rates at extraordinarily low levels will stimulate the economy by providing people with cheaper access to credit. But for all the econ lingo, one wonders how the Fed’s interest rate policy affects the average guy or gal. Specifically, how does a program that keeps interest rates near zero relate to students looking to borrow money to pay for tuition, housing, and credit card purchases? For starters, a quick look at the Fed’s monetary brainchild is a must.
Every night, banks across the US lend money to each other to maintain enough cash on reserve for customers. As the central bank of the United States, the Federal Reserve sets the interest rate which banks charge when lending money to other banks. Borrowing on credit between banks worked smoothly until the housing market hit bottom in 2008. The Great Recession left cash-strapped banks unable to pay up, not just on loans made to one another, but on risky mortgage-backed speculations made during the housing boom of the early 2000s. Here’s where Quantitative Easing comes in: to save banks such as Citigroup from defaulting on their loan payments, the Federal Reserve began to buy billions of dollars worth of their “toxic” assets, particularly government bonds and corporate securities. The Fed’s purchases have given the banks a lifeline by providing them with new cash reserves from which they can both lend money to people and pay off bank debts. According to Professor Arthur E. Wilmarth, the director of GW Law’s Center for Law, Economics and Finance (C-LEAF), the Fed has in effect become a “lifeboat” for sinking banks by buying up nearly $1.5 trillion in mortgage-backed securities from them. The Fed has set the interest rate at which banks lend to each other at .25%, Professor Wilmarth explained, in order to provide banks with further breathing room. By keeping the interest rate at such a low level, the Fed hopes that banks will have more money in reserve, making it cheaper to borrow and in turn allowing businesses and consumers to stimulate economic growth with their purchases.
So where does Quantitative Easing leave the average student? Low interest rates affect everything in our lives, including the amount of money spent on obtaining loans to finance schooling, housing, and automobile purchases. By keeping the banking system afloat, the Fed kept rates on credit card loans and student loans far lower than they would have been otherwise. Had the Fed chosen not to inject banks with extra cash by buying their mortgage-backed securities, the result would have been nothing short of catastrophic. Purchasing eggs from Trader Joe’s by MasterCard or Visa, for instance, would mean paying exorbitant interest fees come the end of the month. Buying that first Toyota after graduation would mean putting up a huge down payment and facing steep monthly installments. And while tuition costs to attend graduate schools are already through the roof, Quantitative Easing relieved students from coughing up far more than the current 6.8% interest rate on federal student loans. All in all, the Fed has assured students along with other members of the population that borrowing on credit will remain cheap—at least until the waning days of 2014.
But as always, there is a downside to drinking the Kool-Aid. It has long been known that if left unchecked, inflation (the rise in the price of goods and services) can lead to the loss of significant purchasing power. The money that the Fed used to help the banks cut their losses didn’t just come out of thin air. Ben Bernanke and the high priests at the Fed have been printing dollars to make toxic securities purchases ever since the 2008 crash. Professor Wilmarth points out that, thanks to the Fed, “US banks are currently sitting on over $1 trillion of un-invested cash because no one knows where the demand is going to be.” Indeed, banks have largely been unable to unload their large cash reserves because of low consumer demand for real estate and commodities. Professor Wilmarth warns that as the economy improves and more people such as graduating students get jobs, consumer demand will rise. This in turn will lead cash-rich banks and corporations to chase after those with disposable income. With an increase in consumer demand, prices in the housing and commodities sectors will rise, giving the green light for inflation. Faced with a surging inflation, those living on fixed incomes, particularly pensioners and federal and state employees, will suffer the most.
The dark side to Quantitative Easing certainly demonstrates that there is no such thing as a free lunch. What will happen once the Fed releases its hold on its low-interest rate policy is purely speculative. Students going out into the real world after graduation should be aware, however, that the danger of inflation clearly lurks beyond the horizon of cheap credit. Quantitative Easing may have solved our worries today, but as tomorrow’s workforce, students should consider their options wisely. Borrowing lots today may seem like a good idea. But paying tomorrow can be an expensive nightmare.