The present state of the U.S. economy can be personified as an ill patient, heading towards immobility, subjected to drugs, not known to be effective or safe. The drugs refer to the concept of Quantitative easing. The term has been in the global news as much as Anna Hazare has been doing the rounds in India. Let us examine this term closely.
Central Banks resort to lowering of interest rates in a slow economy to encourage public buying and discourage them to save. But with interest rates in the developed nations hovering around the zero mark, there is no option available. The apex banks then resort to an unconventional method of "Quantitative easing", which involves pumping electronically created money directly into the economy, by buying private bonds, securities and mortgages from other banks and financial institutions. QE helps in liquidating the market which results in rise of asset prices- share prices; real estate etc. The national wealth and availability of cheap credit encourages buyers. It also helps in devaluing the currency, which influences exports. The increased demand ramps up production which creates employment and enhances the levels of economic activity.
Quantitative Easing: Boon or a bane?
It is not all that rosy though. QE may seem to be a rational response to an economy in dire straits, with nearly zero interest levels and high levels of unemployment, but the inflationary aspect of QE may easily go out of control.
Let us imagine a situation where the central bank lends out the excess cash (it creates through QE) from the Federal Reserve bank accounts which results in increased consumer spending. As a result, the ratio of money in circulation to the goods and services would rise, the aftermath of which is a definite inflation. The Fed can counter this by selling off some of the huge inventory of bonds but by doing so, the interest rates would increase because just as increasing the demand for bonds lowers the interest rates, increasing the supply raises them. If inflation rises to uncontrollable levels, the Fed has to sell off the bonds which would drain out the money from the private economy at a rate that could terminate in sharp recession, one that the world economy witnessed during the early 1980s.
The after effects of the first two rounds of QE have raised the eyebrows of many economic experts and policy makers, who question the feasibility of having a QE 3. Round 1 of QE was announced during the recession of 2008 to stabilise a struggling economy post the housing bubble and the Wall Street crash. Consequently in 2010, the FOMC (Federal Open Market Committee) announced a $ 600 billion second round of QE in order to promote a stronger pace of the economic recovery and to ensure that the levels of inflation is at levels with its mandate. Experts now argue that when QE 2 was announced last year, the unemployment level was 9.5%, now it is 9.1%. Neither is the dollar performing too well, presently rated 6.8% lower than what it was when QE 2 was announced
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Fed Chief Ben Bernanke @ Jackson Hole
Things look gloomy with the economy growing at a yearly rate of 1% in the second quarter, an intangible increase from a growth of 0.4% in the first quarter of the year. Factors such as high unemployment levels (9.1%) and close to zero interest rates (0.1%) are responsible for the sluggish quarterly performance. In his address to the nation in August 2010, the Federal Reserve chief, Ben Bernanke promised that the Fed would take all possible measures to boost America’s sluggish growth. Exactly a year later, Fed chief calls upon the politicians to take the initiative to do more. Strategically, given the fragility of the economy it is a timorous response. Regarding the mayhem in euro-zone, Bernanke said that he was confident that the policy makers and concerned people appreciate the gravity of the situation at stake and would act accordingly to resolve the issues. The discord between the situation and his response, is quite obvious. He is helpless!!!
The Fed could not have been in a "BETTER" lose-lose situation.There is overwhelming evidence that QE 2 was a big failure, that gave rise to high inflationary levels that dented the middle class, but it remains to be seen whether the Fed launches a different set of tools or pulls out another rabbit a.k.a. QE 3 from its hat. The Fed needs to work in close co-ordination with team Obama and initially look to tame inflation before launching QE 3 or may be, implement a completely different set of tools to revive the global bourses. Well, “to QE or to not QE” remains a grey issue that needs to be addressed tactfully by the concerned in the near future.
