Waiting for the FED

While we (and financial markets) wait on the results of the US Federal Reserve's Open Market Committee (FOMC) meeting which begins today and will culminate in the release of a statement at 2:15 pm (EST) tomorrow...

It is important to understand the key roles that central banks have played in trying to guide monetary policy since the financial crisis began in 2008.

• The FED's key role is to safeguard the stability of the US financial system:
• This mandate includes:

1. promoting maximum employment
2. promoting stable prices
3. promoting moderate long-term interest rates

Historically, in relatively normal circumstances, monetary policy was achieved with the raising and lowering of interest rates (in the US, the FED would determine the base rate).

However the extraordinary circumstances that were created by the "Great Recession" called for extraordinary monetary measures now commonly referred to as QE (Quantitative Easing).

This is where the FED made bond purchases for it's balance sheet from the bond market and in turn added significant liquidity (cash) to the economy to maintain the stability of the system.

Critics claim that this monetary stimulus did not all make its way back into the system (some institutions were hoarding cash for safety reasons) and was not as effective as a result, however strong equity markets and improved economic growth over the last couple of years have shown that it has been effective.

Economic growth is a function of psychological confidence held by the households and businesses which participate in the economy.

When households feel confident in the future they will consume at a higher level. When businesses feel confident, they will invest in future growth.

What the FED and other central banks around the world have been trying to do is instill confidence in consumers (they will have jobs in the future) and businesses (consumers will return) in an effort to change the psychology from the lack of confidence created by the financial crisis and the ensuing recession.

Fortunately the FED was proactive and realized early on that extraordinary measures were necessary.

Other central banks have followed their example.

For those that want instant gratification, they may be disappointed. The positive results will take time to achieve. It is no simple matter to change the negative psychology that has been built up.

Patience is required.

I am a cautious optimist. I can see the benefits of the central banks' efforts and know that in time they will prevail and that their methods will prove successful. It is why we must focus on the long-term. There will be short-term difficulties, but given time, we will all be better off.