Stocks surged today after Wednesday's announcement that the Federal Reserve will purchase $600 billion worth of Treasury securities to boost the stagnant economy.
The S&P 500 stock index rose 1.9 percent to its highest since the start of the financial crisis in September 2008, when Lehman Bros. collapsed. The Dow Jones Industrial Average surged 219 points or 2 percent as of its 4 p.m. close. Markets around the world rallied on hope that the Federal Reserve can somehow return jobs and investment to pre-crisis levels.
The most direct effect of the Fed's move will be on interest rates and consumers' investments.
This is the Fed's main tool for changing monetary policy. The Fed is going to print more money, thereby making money cheaper to borrow and interest rates lower.
"One could argue that interest rates are too low already and Treasury prices are too high," said James O'Sullivan, chief economist with MF Global.
Lower interest rates also could lead to lower mortgage rates for consumers looking to buy a home. Consumers who couldn't afford to borrow money or didn't want to borrow money now have greater incentives to do so at lower rates. With more people buying homes, the prices of homes could increase and lead to a boost to the housing market.
For consumers with investments in the financial markets, a large purchase like the Fed's, which will take place at a pace of about $110 billion per month until June 2011, theoretically should encourage investors to place their money in places with higher risk and returns, like the stock market, instead of low-yielding bonds, for example.
As those assets increase in value over time, that means a better stock market and potential gains in wealth for people who own stock for retirement or general purposes.
"They expect this to have a positive impact from lower interest rates and they think it will induce bankers to lend more money, but that's an unsupported premise," said Bill Bartmann of Bartmann Enterprises. "There's a lot of supply but no demand. This will not increase demand if the rate is so shockingly low already."
Prior to the announcement, economists originally expected the Fed to buy about $500 billion worth of treasuries. That amount could potentially add 2 to 3 percentage points to GDP growth in each of the next two years by the Fed's projections, according to MF Global's O'Sullivan.
"A $500 billion purchase would not have had a huge impact on growth. If needed, the Fed could scale it up," O'Sullivan said of the Fed's ability to increase its purchase size beyond the $600 billion.
But there are dangers that purchasing too much will have a greater effect on interest rates than expected.
"There's a risk that that Fed officials will boost inflation expectations more than they drive down interest rates," O'Sullivan said.
And greater inflation leads to more unstable, higher prices for commodities and consumer goods.
In addition to the risk of inflation, there could be other unanticipated effects. A decrease in the dollar, or cheaper money, is better for U.S. exporters, who can attract foreign buyers with less expensive goods. However, it's worse for travelers and companies who have less purchasing power in other countries.
Mickie Siebert, chairwoman of Muriel Siebert & Co., said only drastic results would cause the Fed to change the direction of its $600 billion purchase plan.