Thursday, February 14, 2013

What is Quantitative Easing?

What is Quantitative Easing?

(Sounds very much like my Noble Solution the The National Debt to me)

Central banks usually strengthen the economy through a single, vastly powerful tool — lowering interest rates. When the Federal Reserve makes it cheaper for banks to borrow money, that stimulus generally flows through the entire economy, as the banks make loans that in turn stimulate economic activity.

But when times are so dire that banks are reluctant to lend or borrowers to borrow whatever the cost, interest rate cuts lose their punch. That happened in Japan after the bursting of its real-estate bubble in 1991, and happened again in the wake of the credit crisis that upended Wall Street in the fall of 2008. In those circumstances, central banks turn to what economists call “quantitative easing’' — unorthodox methods of pumping money into an economy and working to lower the long-term interest rates that central bankers do not usually control.

The most usual approach is large-scale purchases of debt. The effect is the same as printing money in vast quantities, but without ever turning on the printing presses. The Fed buys government or other bonds and writes down that it has done so — what is called “expanding the balance sheet.” The bank then makes that money available for banks to borrow, thereby expanding the amount of money sloshing around the economy thereby, it hopes, reducing long-term interest rates.

And buying bonds drives down rates by increasing competition for the remaining bonds, forcing investors to accept a lower rate of return or move their money into other, riskier assets.

The Fed has engaged in several rounds of quantitative easing. The first round of bond purchases, known as QE1, aimed to arrest the financial crisis, in part by clearing room on bank balance sheets. The second round, called QE2, was started amid concerns that prices were increasing too slowly, raising the specter of deflation. This round, by contrast, is aimed squarely at the huge and persistent unemployment crisis.

Multiple Rounds

Between November 2008 and May 2010, the Fed bought $1.75 trillion in debt held by Fannie Mae and Freddie Mac, mortgage-backed securities and Treasury notes between November 2008 and May 2010. A second round, dubbed QE2, involved an additional $600 billion in long-term Treasury securities purchased between November 2010 and June 2011.

In September 2011, the Fed began a variant that was called “Operation Twist.’' Instead of expanding its balance sheet by just buying more and more bonds, it sold $400 billion in short-term securities and used the proceeds to buy longer-term ones. In June 2012 the ban announced an extension worth $267 billion more.

In September 2012, the Fed announced a new round of bond purchases, QE3, but with an important difference. For the first time, it pledged to act until the economy improved, rather than creating another program with a fixed endpoint.

In announcing the new policy, the Fed sought to make clear that its decision reflected not only an increased concern about the health of the economy, but an increased determination to respond – in effect, an acknowledgment that its approach until now had been flawed.

The Fed said it would add $23 billion of mortgage bonds to its portfolio by the end of September, a pace of $40 billion in purchases each month. It will then announce a new target at the end of every month until the outlook for the labor market improves “substantially,” as long as inflation remains in check. The statement did not further explain either standard.

The Fed’s statement made clear, however, that it would continue to stimulate the economy even as the recovery strengthened, suggesting that it was now willing to tolerate somewhat higher inflation in the future to encourage growth in the present.

Debate Over Impact

There is broad disagreement among economists about the effects of the Fed’s actions. The Fed’s own research shows it may have raised economic output by 3 percent and created more than two million jobs. Most independent analyses have reached more modest conclusions, and some experts argue that there is little evidence of any meaningful economic impact.

The decision to focus on mortgage bonds reflects the Fed’s conviction that the housing market still needs help, and that lower rates on mortgage loans will produce broad economic benefits. Buying bonds drives down rates by increasing competition for the remaining bonds, forcing investors to accept a lower rate of return or move their money into other, riskier assets.

But many experts said that while the Fed program would help the housing recovery at the margins, even lower mortgage rates would not be enough in and of themselves to spur a strong turnaround, given the weakened financial state of many households.


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