Quantitative Easing (QE) and QE3 / QE-4ever

Lets clear the smoke, what is Quantitative Easing (QE)?
Quantitative easing is pretty much creating money to spend it. Nice eh?

So what is this whole thing we hear about Quantitative Easing? Ben Bernanke (the Federal Reserve Chairman) recently announced that the central bank is going to launch a “new and improved” form of quantitative easing until the labor market has rebounded. What does this mean? Until the economy turns around, the Federal Reserve will pump in money through the purchasing of long-term financial assets (such as mortgages). That is basically what Quantitative Easing is, use new money to buy assets, therefore flooding money into the economy with the hopes that banks will lend.

Now why are we talking about Quantitative Easing? 

Well, unfortunately the powers that be have decided (probably rightfully) that we are in need of additional monetary expansion, that is we need to increase our money supply, in order to help the economy get back on the right track. I say unfortunately because Quantitative Easing is a last resort often for economies that have no other tools at their disposal. 

Traditionally the central bank buys short-term bonds to lower bond interest rates, lowers the reserve requirement for banks, and pays less to banks storing money to incentivize increased loaning. The problem we have now is that our interest rates are close to zero, and we have exhausted these traditional means, especially if we ever want to be able to use them again.

Quantitative Easing is the answer we have been forced to take, since short-term interest rates are close to zero, the Fed can only lower long-term interest rates by buying bonds with longer maturity dates. The effort again is to encourage banks to lend.

What is this about QE3?

Well, we have tried Quantitative easing to combat our current economic crisis, twice in fact previously. In 2009-2010 the Federal Reserve announced it was injecting 1.7 trillion dollars into the monetary system by a little heard of method, known as Quantitative Easing. This was soon followed by an additional $600 package known as QE2. 

So is QE3 just the third round of this bond buying? Not really.

The prior QE rounds had set dollar amounts that were injected quarterly, with an end to the purchase cycle. What Bernanke has recently announced is a continuous cycle of asset purchases, at the tune of $40 billion a month indefinitely. Well, at least until the markets stabilize and show positive signs of strong growth.

What is the problem?

The problem we may have with “QE4-ever” has a lot to do with the downside risks to Quantitative Easing. As you already know, money is shoved into the system and banks are supposed to lend. 

But do banks really lend? Well, that is debatable – but in theory, they should. 

The real problem we need to be concerned with is inflation. Lately we have been hovering around 1.5-2.5% inflation, but this rate hasn’t been so stable. These rates are right around our target inflation rate. With additional Quantitative Easing, the Fed has to be very aware of the inflation rates and where they are heading, because flooding additional cash into a warming economy can be dangerous. Inflation rates of 3-5%  are not horrible, and we could probably manage, but only if we are also growing. If we start climbing up above 5% and  cannot bring along growth with that, we enter stagnation and we really don’t want to be there.

So the Fed has a lot on their plate moving along with these Quantitative Easing measures, and QE4-ever (QE3) is a dangerous, but perhaps necessary path to sustained recovery. 

Has QE worked? If so, why QE3

I won’t get too much into this, partially because it would take forever, but also because the evidence is largely inconclusive (some say yes, some say no). But according the the International Monetary Fund (IMF), Quantitative Easing reduced the systemic risks during the financial collapse, helped turn the economy to modest growth, and increased investor confidence.

I hope you guys all learned something here, if you have questions, comments or feedback please let it be known!

Blog’s twitter: Ideafart
Author’s twitter: DanielSethMcKay

6 thoughts on “Quantitative Easing (QE) and QE3 / QE-4ever

  1. Pingback: Quantitative Easing (QE) and QE3 / QE-4ever - What the? | Webpages Attractive Artistic Designs | Scoop.it

  2. Reply Andrew Sep 28,2012 %I:%M %p

    I understand that the economy needs more liquidity, but I don’t understand why it has to go from the Fed to the banks, with the hope that it will go outward from there.

    Why not go directly from the Treasury to bond holders? The threat of inflation isn’t nearly as potent if creditors are compensated for their loss, and paying off (part of) the national debt can only be a good thing. If it were up to me, I’d completely shut banks out of the loop for being so negligent with other people’s cash. You could maybe cause deflation by choking out M3 money supply (when you let banks fail), but most of that money just goes from bank to bank anyway, right?

    Fractional reserve banking is always precarious, because it only works to your advantage when times are good. It’s not necessarily evil, but I would like to see much higher reserve requirements and accountability for overleveraging.

    Nice choice of illustrations, by the way.

    • Daniel McKay Reply Daniel McKay Sep 28,2012 %I:%M %p

      There is a huge problem giving the money to the banks, the problem is that they are a business – and when the interest rates are too low they don’t see it profitable to lend. This is what happens when they are flush with money and the demand for new money doesn’t come with it. In theory lowering the rates is supposed to entice people to borrow, but we aren’t seeing that – and so it is no surprise that banks are hanging on to huge stockpiles of reserve cash (it just isn’t profitable for them to compete for mom’s mortgage).

      An interesting thought you bring up is to ‘inject’ money into the treasury, allowing them to pay off loans with new money. It certainly would help pay down the debt…

      I see a few shortfalls. Isn’t this essentially what was proposed for Greece? The credit ratings agencies called it “selective default”. I could see a hit in our rating and confidence abroad should the treasury resort to such tactics (this would be a last resort.)

      I also see that at this time confidence in repaying the debt is pretty high, people want to lend to us. Maybe we shouldn’t risk it.

      I think the Fed is just in a bad position.

      • Reply Andrew Oct 2,2012 %I:%M %p

        Exactly. Theoretically, banks could shift their business focus from house mortgages to commercial real estate or small business loans. I’m not free to say who, but I know that at least one bank has been making the transition. However, such a switch involves real costs and could potentially take a long time while they learn how to evaluate the risks better. After all, they’re understandably nervous about making bad risk evaluations right now.

        A selective default is when you’ve proven that you can only pay some of your debtors. That doesn’t apply here.

        Remember that we lost our triple A rating, not because we are fiscally incapable of paying, but because Congress has proven to be politically unstable in terms of meeting its obligations. An injection of “earnest money” might assuage concerns on that account because it’s something that should appeal to both parties.

        Republicans can boast that they reduced the national debt (or just the deficit, as the case may be) and Democrats can point out that they were able to provide for “working class Americans” (who often have pension funds that buy US treasurys) and improved the economy thereby.

        Then again, maybe direct investment like you’ve proposed would be the better option, I don’t know.

        • Daniel McKay Reply Daniel McKay Oct 2,2012 %I:%M %p

          You may be right here Andrew – although I am still not sure on the effect it might have on the creditors who begin to realize the treasury doesn’t have responsibility of repayment (it has gone to the Fed). If it is small, perhaps none. It could be potentially a win-win as you suggest.

          Side note: I have this feeling that our loss in the credit rating didn’t affect peoples views on the soundness of the debt. If we look at the period we lost our credit rating absolutely nothing happened to our ability to borrow (in fact rates have declined)

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