Quantitative Easing pt. 1

As the reign of Ben Bernanke comes to a close and The Fed looks forward to Janet Yellen, I feel it is appropriate to examine the monetary policy that has come to be a hallmark of The Federal Reserve....quantitative easing. This will be the first of many….many articles about The Fed so don’t worry, there’s plenty more to come.

What is quantitative easing?

Well, quantitative easing (“QE”) is a central bank’s (i.e. The Federal Reserve, European Central Bank, Bank of Japan)  last ditch effort to keep money circulating in the market. When typical monetary policies fail, such as purchasing government bonds,  a central bank purchases large sums of financial assets from commercial banks at designated time periods.

What is this supposed to accomplish?

During a severe financial crisis, banks will try to hold onto their money and reduce the number of loans they give out, thereby reducing the number of purchases made by consumers. The reduction of purchasers made by consumers then further worries banks. 

How do banks respond? 

By further reducing the number of loans they give out. It’s a downward spiral to financial ruin. By purchasing financial assets the Fed gives banks more money to potentially lend out to consumers and increase spending.

Why do you want to increase spending?

According to Neoclassical and Keynesian economic thought (together making up “mainstream” economics) spending is how a country gets out of a finical crisis. More spending ---> More production ---> More jobs. 

Does it work?

Kind of. Many economic papers have been written concluding that the great recession could have been much worse if Bernanke had not engaged in aggressive QE and it is generally accepted that QE was the right course of action. 

An argument against QE is that artificially low government bond yield rates induced by QE will have an negative impact on pension funds, since "without returns that outstrip inflation, pension investors face the real value of their savings declining rather than ratcheting up over the next few years.” 

Yikes.

Whats important here is the phrase “few years.” Yes, over the term of QE your pension may very well decrease, but the short term reduction is better than complete and utter financial ruin - which is what many think could have happened without QE. 

How does it affect you and me?

If you were thinking of retiring circa 2009, you probably didn’t. Your bonds didn't mature at the rate you expected and you may still be working to accumulate the money you lost during  QE.  Beyond the bonds, the failure of the housing market left many of the elderly homes' "under water". So those who thought about retiring couldn't even sell their homes to make up the difference.

Unfortunately even if you are relatively young, you may never get back the returns that QE diminished. Even so, it looks like  QE helped us avoid another great depression and its affects are walking the US back to economic stability. 

Unless we somehow default. I'm looking at you, Congress.