QE3

Across the United States, news organisations have been abuzz with the word QE3 or the potential third round or quantitative easing to stimulate the US Economy.

But quantative easing is essentially only one of the many monetary tools to pump in more money into the economy. Central banks implement  it by purchasing financial assets like bonds and treasury assets  from banks with newly-printed money. That increases the money supply in the economy when bank rates are at or near zero levels.

The goal is to allow businesses to borrow and spend more freely and keep interest rates low by ensuring there are ample supplies of cash.

The bank will first credit its own account. Once that is done it will begin to buy assets like government bonds, corporate bonds and treasury bills from banks and other financial institutions through a process called open market operations.

The purchase then enables the bank to build its reserves. With these excess reserves, the bank can create new money  which in return stimulates the economy.

Examples of economies where this policy has been used include Japan during the early 2000s, and the United States and United Kingdom during the global financial crisis of 2008–2009.

The first round of easing (QE1) by the Fed tried to infuse money into the moribund housing market in the US in 2008-09, while the second round  (QE2) was meant to boost overall credit levels among US consumers and businesses. In addition, interest rates were pulled down to near-zero levels in a bid to further encourage borrowing and spending.  In all, the Fed spent about $2 trillion on QE1 and QE2.

Yet, that  huge gush of liquidity has not had its desired effect. High debt levels among consumers (consumption accounts for 70 percent of the US economy) has inhibited borrowers from taking new loans before the old ones are repaid. Among companies, low demand from consumers has kept investments muted. Flush-with-cash banks have also been reluctant to lend.

In addition, a lot of the money went into the stock and commodity markets, sending prices of everything, from stocks to oil to new highs, and increasing foreign fund inflows in emerging markets. Both have led to soaring inflation in several economies.

Because there are growing fears that the economy could slide back into a recession, some economists and market experts are betting big on a new round of stimulus.

Yet, the big question is whether another round of money-throwing will help the US at this point.

 

Updated Date: Aug 10, 2011 11:45:29 IST



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