Weekend Economists in the Children's Hour: Hallowe'en to El Dia de Los Muertos, 2014

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54. Central Banks Answer the Markets’ Prayers (For Now)

http://go.bloomberg.com/market-now/2014/10/31/central-banks-answer-markets-prayers/

It’s the party that just keeps going: the first batch of guests leave, the next ones arrive. Just as the U.S. Federal Reserve winds down its asset purchases, the Bank of Japan expands its own program. World stock markets, rejoice!

For a while anyway. So far, quantitative easing, the policy of national bond purchases has arguably succeeded in perking up the economy, almost certainly succeeded in helping along the stock market and (this is key) certainly not led to the out-of-control inflation that critics predicted. Bloomberg Businessweek’s Peter Coy answers some of the folks who were sure bond buying would lead to economic catastrophe and still won’t admit they’re wrong.

That said, don’t get too comfortable. Central bank asset purchases dramatically lower bond returns and effectively push money into the stock market. When they end, the flow of money reverses.

The idea is to do it slowly and gradually and not cause a panic. So far the Fed is succeeding. However, over the long run pulling out of the stimulus without scaring the markets is a tough difficult maneuver to pull off (and stock market returns aren’t necessarily the central bank’s concern. The Bank of Japan pulled out of its last stimulus program, in 2006, fairly smoothly. But as the chart below shows, it was the prelude to three years of market declines.