It sounds like the name of an honored Transatlantic ship, but this time the QE2 stands for the Federal Reserve Board’s second attempt at an economic stimulus with the name Quantitative Easing. Will this new round help keep the economy afloat and chugging toward an expansion?
With QE2 the Fed is trying to lower interest rates at a time when short-term rates are already as low as they can go. QE1, the first round of stimulus, which drove up short-term Treasury prices and lowered short-term interest rates, is largely credited with saving the economy from sinking like the Titanic.
In an attempt to buoy a somewhat becalmed economy, the Federal Reserve will spend at least $600 billion to purchase Treasury bonds further out on the yield curve with maturities in the five-to-10-year range. The aim is to drive up the price medium-term bonds and reduce medium-term Treasury interest rates by about 25 to 50 basis points.
How will this set raise the economy tide?
The hope is that QE2 will further drive down mortgage rates, allowing people to refinance and buy new homes. And since the Fed is largely buying up all the Treasuries in this maturity, fixed-income investors will have an incentive to buy corporate debt, which in turn should increase the ability of companies to invest and expand the economy.
This second stimulus will also make money easier and cheaper for companies to borrow, presumably helping to ease an ongoing credit crunch. Higher bond prices should also stimulate investment in stocks, and the markets have already reacted positively to the news. Because QE2 is the U.S. government effectively printing new money, the value of the dollar should drop, creating cheaper U.S. exports.
There are a lot of doubts about whether or not the QE2 will make it safely through the Scylla of inflation and the Charybdis of deflation. Many people can’t afford to refinance and are barely holding on to their homes as it is. Meanwhile corporations and banks are hoarding billions in cash already that they could be using for investment. And as investors increasingly turn to the stock market as an alternative to meager bond income, market bubbles may well be forming, particularly in commodities and emerging markets. What’s more, printing money always raises the specter of inflation, which, in an economy awash in debt, is a bogeyman waiting to pounce.
In defense of the Ben Bernanke’s Fed, so far he has rescued the economy from Davy Jones’s locker. As a student of the Great Depression, he may the perfect person to be at the helm. More important, the Fed has a mandate to protect us. Unemployment is still too high and inflation too low for it not to use what tools it has at its disposal. Ultimately the plan is for the Fed to suck up the money it is flooding into system before a tsunami of inflation can cripple the economy. Can they do so in time? Will QE2 get the economy cruising along at a stronger rate?