Fed Hints at Potential of QE2 - Bargaineering

Posted: 02 Nov 2010 09:28 AM PDT

The Fed, in it’s FOMC meeting notes (September 2010), announced that it might be using quantitative easing again this year, with the market calling it QE2. In it’s September meeting, it echoed sentiments from its August meeting about the slowing economy and stated that the Committee is prepared to provide “additional accommodation” if necessary – codeword for quantitative easing.

Why is this notable? If the economy were really recovering as nicely as many of us would like to believe, then quantitative easing wouldn’t be necessary. If we’re back on track and we aren’t facing deflation, QE1 worked, and we should just continue on with business as usual. By mentioning the potential for another round of quantitative easing, the FOMC introduces the idea that maybe we’re not recovering as nicely.

Don’t get too excited though, last week the WSJ said that QE2 might not happen…

It’s also important to note that in the notes they said that “Information received since the Federal Open Market Committee met in August indicates that the pace of recovery in output and employment has slowed in recent months.” (matching what they said in August about June data) and “… the pace of economic recovery is likely to be more modest in the near term than had been anticipated.” (also matching August).

The zinger was this line – “The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.” That’s the one that seems to predict some future quantitative easing, potentially at November 2nd-3rd meeting today and tomorrow.

I suppose we’ll see what actually happens but the market has already priced in the fact that additional accommodations will be provided.

Fed Hints at Potential of QE2 from personal finance blog Bargaineering.com.

What is Quantitative Easing?

Posted: 02 Nov 2010 04:08 AM PDT

Quantitative easing, known as QE, is a monetary policy used by a central bank to increase the money supply by increasing the excess reserves. In layman’s terms, they inject a lot of new money into the money supply through open market operations. If this sounds like the central bank is just printing more money, you’re right (technically they just make up money out of thin air electronically, no actual printing is necessary). The specifics of how they do this are probably not important to 99.99% of us, but they’re explained below, but what is important is why a central bank like the Federal Reserve would want to do this.

How is QE accomplished?

(in case you were curious) The central bank essentially credits its own account with new money and uses that money to buy assets from banks, thus increasing the reserves at those banks. Those banks can then lend that money out at a multiple based on the reserve ratio. If the ratio is 10%, then they can lend out 90% of the amount of the added reserves. Reserve ratios are the percentage of an asset they must keep as reserves (so if you have $100 and the ratio is 10%, you can lend out $90). The next bank can lend out $81, keeping $9, and so on and so forth.

Why do they use QE?

As you may be aware, the current federal funds rate is remarkably low – target is 0 – 0.25%. If additional stimulation is needed, they can’t exactly lower the federal funds rate to under 0%, then banks would be paid to borrow money from the Fed (and they would borrow an infinite amount!).

Quantitative easing is just another monetary policy tool they can use to inject money into the money supply to spur lending and boost the economy.

What are the risks of QE?

The biggest risk is hyperinflation, as it’s happened in a variety of places. Whenever you print more money, you devalue existing money since the underlying characteristics of the economy have not changed. Simplistically, if your economy is worth $1000 and you have 1,000 bills, each one is “worth” $1. If you print 1,000 more bills, each one is really worth just $0.50. In enormous economies worth trillions of dollars, the degree to which you print more money has the effect of nudging the economy in certain directions. The risk is that a nudge becomes a push or even a shove… down a hill. (Think: 1920s Germany following World War 1 and Zimbabwe in the early 2000s)

There you have it, quantitative easing in a nutshell.

What is Quantitative Easing? from personal finance blog Bargaineering.com.