Debt Crisis: Is the Fed Headed for a Third Round of Quantitative Easing?

ForexNewsNow | Published on August 12, 2011 at 12:07 pm

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NEW YORK (ForexNewsNow) – Most of us are familiar with the Fed’s usual methods of regulating interest rates to stabilize the economy, yet the current Debt Crisis appears so severe in scope that the Fed is rumored to be considering a third Quantitative Easing policy.

This unorthodox technique consist of allowing the central bank to go above and beyond its traditional monetary policies in order to counter the threat of the looming “Double Dip” recession that’s seems all but unavoidable. Traditionally, the central bank is limited to the adjustment of interest rates to stimulate the economy – it increases interest rates when inflation is on the rise and decreases interest rates when the economy is weak.

Yet in some cases, such as Japan in the early 1990s and the current situation sweeping over the Euro Zone and the US today, this tool is simply too weak to give the economy the jump-start it so badly needs.

After having cut interest rates to their lowest possible levels (0% to 0.25%) and undertaking two rounds of Quantitative Easing, the Fed has still been unable to stimulate the desired levels of demand and investment in the US economy. Therefore the central bank is now considering a new package of  “unconventional” measures to stimulate the economy, which, however unoriginal it may be, can only be labeled the third round of the Fed’s Quantitative Easing or “QE3” policy.

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If approved, it is still unclear what kind of measures this package will include, yet many analysts believe the Fed may buy long-lived assets, including risky ones, both to private institutions and to the US Treasury in order to inject liquidities into the market, which will hopefully be used to finance new loans for households and businesses.

If this sounds like something you’ve heard before, you are not mistaken. In 2008, the Fed purchased $100 billion in assets and repeated this purchase in 2010 with a whopping $600 billion purchase of assets in what was labeled the Quantitative Easing 2 policy or  “QE2″. Following these purchases the Fed is now one of the main holders of U.S. Treasury bonds.

Despite the high hopes that such a policy could save the US economy from another major recession, Ben Bernanke, the current Chairman of the Federal Reserve, still has many reservations about the plan. While, on one hand it is tempting to continue to purchase assets in an effort to help the U.S. economy, on the other hand the “Quantitative Easing” policies have been highly criticized by emerging countries. These rapidly growing economies, such as China and Brazil, content that the injection of money caused by Quantitative Easing is only re-invested in high growth economies, where it remunerates more and contributes to inflation, rising interest rates and devaluation of the national currency in fast developing countries. Both China and Brazil strongly protested against the “QE2” in late 2010 and are viewed as potential obstacles to a third round of Quantitative Easing.

For now, it seems that Bernanke has decided to refrain from embarking on “QE3”, but it remains to be seen how long Bernanke can maintain this position in the face of the increasingly substandard performance of the US economy.

 

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