Since the
latest recession, the Federal Reserve has instilled periods of quantitative
easing, also known as QE. This term is what the policy of buying bonds and
assets to increase economic growth has been called by the Fed. By the end of
2013, a tapering process for the bond-buying was supposed to begin but has
recently been put on hold by the Reserve.
But what
exactly is quantitative easing, how does it work, and how does it affect the
economy?
What is Quantitative Easing?
Quantitative
easing is the name of the Federal Reserve’s program for buying bonds from its
member banks. The purpose of quantitative easing is simply to reduce interest
rates and increase growth of the economy.
QE3, the most
recent policy, has the Reserve buying 85 billion dollars of bonds every month
to push money into the economy. Recently, the Fed has announced that it will
eventually phase out the amount of purchases if the economy improves. Yet the
tapering will begin later than expected.
How Does Quantitative Easing Work?
The Federal
Reserve credits the banks’ reserve accounts in exchange for MBS and Treasuries.
The reserve account is the amount that each bank must have when they close
nightly.
According to
the Reserve Requirement, the banks must have 10% of deposits at the local
Federal Reserve Bank or in cash.
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When the
Federal Reserve adds credit, the banks have an extra amount on reserve, which
can lead to banks lending to other banks. When the banks try to release their
reserves to other banks, the interest rate drops (this is the Fed funds rate,
the root for all interest rates).
Why do they do it?
Quantitative
easing increases the supply of money because lower interest rates allow the
banks to increase their amount of loans, which allows business to expand and
consumers to take out credit.
This keeps the
dollar’s value low, making stocks seem more attractive to foreign investors, as
well as American goods for exporting.
Does it work?
After the
creation of the bond-buying program, rates fell slightly. For the average rate
of a 30 year mortgage, the rate went from 3.55% at the creation of QE3 to 3.35%
in May, according to Freddie Mac. There has also been a 17% increase since the
launch of QE3 for sales of existing homes.
The San
Francisco Federal Reserve Bank published a report in the summer that stated
QE2, a quantitative easing program dealing with asset-buying, added less than
one percent to the rate of economic growth overall, but 2.8% initially. This
overall did not help much to spur growth and create jobs. The report said that
any growth was mostly due to the low interest rates, allowing people to make
long term investments.
As stated in The Economist, Unemployment has gone from 8.1% to 7.3%. The
goal was to stop QE when it hit below 7%, yet job growth has slowed down again,
with the labor-market participation at the lowest it has been in over 30 years.
Debt rates across the nation have fluctuated as well, with people relying on
services such as National Debt Relief to assist them in financially
difficult times.
Will interest rates rise, if bond purchases
end?
It’s already
happening. Since the idea of ending the stimulus caused an increase by 1.2
points since its arrival in May; new home sales have decreased steadily since
July, as did contracts to buy older homes.
How will it affect the economy’s recovery?
On September
18, the Federal Reserve released a statement about QE and the decision to not
instill tapering quite yet: “To
support continued progress toward maximum employment and price stability, the
Committee today reaffirmed its view that a highly accommodative stance of
monetary policy will remain appropriate for a considerable time after the asset
purchase program ends and the economic recovery strengthens.”
The Chairman
of the Federal Reserve, Ben Bernanke, said that the Fed will decrease its bond
buying if they think the economy is gradually improving but if growth stalls
again, the bond buying will continue. Bernanke also said that if the economy
grows faster than expected, the bond-buying will end sooner than its expected
mid-2014 date.
Dave Landry
Jr. is a small-business adviser and investor who enjoys blogging and interacting
with financial consultants and entrepreneurs on the web. He hopes you
enjoy this article.