What is Quantitaive Easing-QE

QUANTITATIVE EASING (Q.E.2)

The US Federal Reserve is desperately trying to fix the economic system that broke down in 2007. Incomes in the US were skewed in favor of the rich, while the poor while the poor got skewed. It relocated production to the emerging countries , where cost were very cheap, and it piled on debt to consumers by keeping interest rates low. Due to this consumer confidence lost and US economy now needs money so as to make people rich which will increase production and will give rise to inflation. Also it will increase employment. So let’s understand this process of printing more money which is termed as quantitative easing or Q.E.

Q.E- It is done by buying bonds usually government paper but can also be private bonds from banks and financial institutions. Till now Japan, Zimbabwe has done this during its asset bubble period. This helps in creating a wealth effect which spurs the economy. When a government prints money, interest rates drop and inflation rises. This is simply a matter of supply and demand: the same way that corn is cheap in the summer when it’s plentiful, the Fed is making it cheaper to borrow dollars, by flooding the market with them.

Q.E 1-On 25th Nov. 2008, the Fed announced QE1, a plan for buying $100 billion of agency debt and $500 billion mortgage-backed securities (MBS). The 10-year yield fell from 3.35% to 3.02% immediately. The dollar index fell and on March 2009 Fed purchased agency debt to $200 billion, MBS to $1.25 trillion and added another $300 billion of treasury securities to its purchase plan. The dollar fell to 74.7 at the end of Nov 2009. Asset, commodities prices moved up but it posed a threat to emerging countries as interest rates in US is zero so investors will invest their money in emerging countries which will pose a threat to these countries.
Q.E 2- On Aug. Fed announced another round of QE and this time they may print $900 billion and be completed by the end of the third quarter of 2011. The central bank will buy $600 billion in long-term Treasuries. The Fed also said that it will reinvest an additional $250 billion to $300 billion in Treasuries. The Fed wants a return of inflation in the US and in turn GDP expansion.

Implications-For the world economy as a whole, this system may set the stage for an even bigger crisis even if it succeeds. Devalue of dollar will take place. Already there is currency war between US and China which may increase. Asset prices will increase which will lead to over-valuation of markets. Emerging countries will need to cap on FII inflows into their country. Too much monetary stimulus might lead to runaway inflation that could derail the economy, or future asset bubbles that could endanger economic stability over the long term in US.