Quantitative easing (QE) is a monetary policy that central banks
(in this case, The Fed) use to stimulate the national economy when traditional
monetary policy is ineffective. Usually,
if the Fed wants to stimulate the economy, they purchase US Bonds in order to
increase the demand for these assets driving up the prices and lowering the
yields (interest rates). By lowering
interest rates, the cost of borrowing money is reduced which will allow
businesses and consumers to borrow to increase their expenditures, thereby
stimulating the economy. With interest
rates at or near 0% this traditional monetary policy is ineffective.
With QE, the Fed purchases assets from commercial bank and
other financial institutions with newly created money in order to increase the
money supply by injecting more money into the economy. Typically, the Fed purchases assets of longer
maturity to lower the longer-term interest rates. By purchasing these assets, the Fed increases
the excess reserves of these financial institutions so they have more assets to
lend at lower rates.
On September 13, 2012, the Fed announced the third round of
quantitative easing – QE3. Through QE3,
the Fed will purchase $40 Billion in mortgage-backed securities per month. The time frame for this round is open-ended.
Effectiveness
There are various opinions as to how effective the three
rounds of quantitative easing have been and what the impact on the overall
economy has been. The International
Monetary Fund (IMF) says that QE has reduced systemic risk globally following
the failure of Lehman Brothers in 2008.
The IMF also stated that these policies have improved market confidence
which led to the bottoming of the economies of the 7 largest economies in the
second half of 2009.
Alan Greenspan, former Fed Chairman, feels that,
surprisingly, the three rounds of QE have had very little effect on the economy. In July 201 he said, “I am very surprised at
the data,” while Federal Reserve Governor Jeremy Stein said that these policies
"have played a significant role
in supporting economic activity.”
Risks
There are several risks to a policy like QE. First, by lowering interest rates it also
lowers rates on savings accounts, pension funds and other assets that earn
income based on prevailing interest rates.
Senior citizens can be adversely affected by interest rates at this
level. The Fed feels that the impact of
these lower rates outweighs the negative effect on lower savings rates.
Inflation is also a big concern of QE3. If the Fed overestimates the amount of
stimulus needed too much money is created by the purchase of these assets which
will ultimately lead to higher inflation.
Last, there is the possibility that these financial
institutions will not use these excess reserves to lend locally to businesses
that have a difficult time raising needed financing. They may, instead, invest in other non-local
investments or emerging markets which will not have the intended effect on the local,
state or national economy. This has been
a major criticism of the QE policies.
Many have called upon the Fed to do more to force these financial
institutions to make more of these excess reserves more readily available.
