Quantitative Easing – Economic Recovery’s Latest Buzzword

Leading up to the Federal Reserve’s November 2-3 meeting, at which economic stimulus measures will be high on the agenda, the concept of ‘quantitative easing’ as a means of encouraging economic growth is garnering its fair share of both critics and supporters. Quantitative easing had been used by the Fed earlier in the current economic crisis, but with limited success. Aptly named QE2, a second round of quantitative easing seems likely to be put into place in which the US central bank will buy up (mostly toxic) assets from banks in an effort to pump money into said banks. The banks in turn can lend this money to businesses, allowing the businesses, in turn, to increase their labor force, thereby channeling money to consumers, boosting consumer spending and jumpstarting the economy.

Although not yet confirmed, and not likely to be confirmed until after the Fed’s November meeting, estimates are that QE2 will pump up to a trillion US dollars into the economy – money that has been conjured up out of thin air and has the potential to cause a devaluation of the dollar, with a risk of causing runaway inflation in the future. History reveals that economies generally don’t reap long term benefits from artificial engineering, and a devalued dollar is very likely to increase the cost of commodities, resulting in consumers finding themselves paying significantly more for basics such as wheat and sugar, as well as America’s favorite legal upper – coffee. Paying higher prices for essentials is likely to result in higher costs, thereby negating, to some extent at least, the desired effect of stimulating the economy.

Another factor that can cause the plan of quantitative easing to go awry is when the banks use this cash injection, not to lend to businesses/consumers that may or may not replay the loan and are therefore risky, but rather to buy treasuries that are safe. Of course, this is not what the Fed wants to achieve, and to ‘force’ the banks to look for other channels of increasing revenue, the Fed buys the treasuries in the market, creating demand and lowering the yield. This makes treasuries less attractive to the banks and thereby ‘incentivizing’ the banks to look into the wider market for investment opportunities and lending money to businesses – and the Fed’s goal is accomplished. What remains to be seen at this stage, is whether the Fed will choose to go the route of quantitative easing despite its inherent risks.