Provided by Mitch Wilcox
Bank of Oregon
Here is one of the best explanations of QE…..
References to QE (Quantitative Easing), and “QE2″ (the 2nd round of QE; the Fed has already used “QE1.”) have been made in financial reports via media sources. What is QE? Why does it matter to us as consumers? Why is this a hot topic?
First, a couple of definitions specific to the financial markets:
Quantitative: A specific amount of money being created. Easing: Reducing pressure on Banks and other financial institutions.
Ordinarily, the central bank (The FOMC, “The Fed”) uses its control of interest rates, or sometimes reserve requirements, to indirectly influence the supply of money. In some situations, such as very low inflation or deflation, setting a low interest rate is not enough to maintain the level of money supply, or to stimulate the economy as desired by the central bank, so quantitative easing is employed to further boost the amount of money in the financial system. This is often considered a “last resort” to increase the money supply with the overall goal of stimulating the economy.
Here’s how it works:
- The first step is for The Fed to “create more money” by crediting its own account. This money is literally created out of nothing by electronically crediting the Fed account. The Fed can then use these funds to buy investments such as corporate and government bonds, agency debt, and mortgage backed securities (MBS) from financial firms such as banks, insurance companies, pension funds, and other financial institutions.
- These asset purchases create excess capital reserves for these financial institutions for lending and investment use via additional account deposits.
- The increased money supply is designed to stimulate lending and the economy overall.
Does it work?
- Hyper-inflation could result if QE is more effective than desired.
- It may be that QE is not effective enough if banks sit on the capital and do not lend.
Has QE been used before? Was it effective?
The US, UK, Japan and the Eurozone have all implemented QE in one form or another over many years, with mixed results. For certain The Fed feels it has to do something, and the economic stimulus tool belt is getting smaller every day.
The first round of QE employed by The Fed had limited success. While interest rates remain at historical lows and some mortgage refinance activity is occurring, The Fed apparently wishes to drive rate down a bit more. Whether this actually happens remains to be seen. The equities market investors (stocks mostly) will have their say in this as a flight to equities could occur if the strategy is not effective. This would result in higher MBS yields which of course raises mortgage rates; MBS managers would need to get those investors back with higher yields. And the beat goes on….
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