Quantitative Easing

What is Quantitative Easing?

Quantitative Easing is the name given to government policy to increase the money supply by injecting liquidity into the economy. This is done by buying government assets back from the market.

The reason behind using this policy is that it will increase the capital within the financial sector and therefore increase the amount which banks lend to consumers and small businesses, in an effort to promote economic growth. This policy is usually only done when interest rates are already extremely low and there are no other measures which can be taken to stimulate economic activity.

Unfortunately, there is very little evidence to show that QE helps at all; in fact the evidence is to the contrary. The negative impact of this easing is that an increase in the money supply without a corresponding increase in demand for money is likely to push up inflation.

For a more detailed breakdown, check out this video:

QE Purpose

Here's a fellow user's outlook on the purpose of quantitative easing:

The purpose of QE is to lower REAL interest rates. There are two ways to do this:

  1. Lower nominal interest rates 
  2. Stoke inflation

Since nominal interest rates are already very low and rates cannot really go through 0 (since people would just prefer cash), the Fed is now hoping to increase inflation through another round of easing.

So I don't think the actual purpose of QE is to debase the currency, but a lower currency is indeed a symptom of their possible success in creating inflation (or staving off deflation).

As an editorial aside, I would also note that for the last decade the Fed has had a perfect record of being dead wrong at the turn of cycles. 

  • In 2003 they were pounding the table about deflation as the housing bubbles were forming
  • In 2006-2007 they were saying housing was "contained" and that inflation was a worry...we know how that ended
  • In 2010 they said deflation is a great risk and more easing is needed

I am placing my bets that the Fed is wrong again and that the economy is fine and deflation is not the bogey-man they think it is....we'll see. 

 

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