QE2: Pros and Cons

by Elaine Schwartz    •    Nov 8, 2010    •    1146 Views

Reminding us that there is no such thing as a free lunch, The Washington Post has an excellent interactive summary of the pros and cons of a QE2 impact.

But first…what is QE2? Through a second round of quantitative easing, the Federal Reserve will purchase government securities. By purchasing securities, the Federal Reserve injects money into the U.S. economy. Very simply, (but not quite exactly the way it happens) the Fed can call you and say, it wants your Treasury bonds. You say “Yes,” and sell them to the Fed for $100. You deposit that $100 in your bank account. Because the bank now has more to loan to people, it can lower its interest rates. Also, you have more to spend.

Who will be helped by these purchases? Anyone who wants to buy a house and can get a mortgage will pay a lower interest rate. Similarly, businesses could find it more attractive to borrow money and expand. Furthermore, stock prices could rise because of the expansion that lower interest rates stimulate. Internationally, lower rates usually lead to a cheaper dollar. Consequently, U.S. exporters benefit because their goods and services are relatively cheaper.

Who will be harmed by these purchases? People with savings (typically retirees) will get lower interest rates for their money. Some believe that injecting large amounts of money can cause too much expansion, inflation, and bubbles. Internationally, if the dollar is cheaper, then imports such as oil become more expensive.

You can see where all of this is going. With valid arguments on both sides of QE2, there is a big split in the economic community. This NY Times economix blog lists equally eminent people on both sides.

The Economic Lesson

Government can guide the direction of economic activity through fiscal and monetary policy. Fiscal policy takes us to spending, taxes, and borrowing. Monetary policy involves the supply of money and credit.

As the source of monetary policy, the Federal Reserve has used three basic tools: the interest rate they charge banks, the size of reserves that banks are required to have on deposits, and buying and selling government securities.  QE1 and QE2 reflect far more extensive buying activity than the Federal Reserve has ever done. Some have even said it equals dropping money out of a helicopter down to the economy.

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