Quantitative easing: What does the Fed's latest move mean for you?
But does anyone really understand what it's all about?
Here are your top 10 questions answered:
What exactly is quantitative easing?
Technically speaking, it's when the Fed goes into the markets and buys financial assets like Treasury securities. In layman's terms, it's when the Fed prints more money and floods the economy with it to reduce long-term interest rates and encourage growth. The goal: to get consumers -- the backbone of the economy -- spending again.
Why do we need another round?
Something needs to be done given the stubbornly high unemployment rate (currently at 9.6%), and lethargic, slower-than-expected growth (forecast to continue into 2011). So, while the first round (some $1.7 trillion) in 2008 was meant to help clean some bad assets off the banks' books, reassure spooked markets, and ultimately prevent a global depression, this time, ($600 billion) it's about shaking the economy out of its slumber and getting companies and consumers to spend again.
Will it work?
There is ongoing debate as to whether this will work/to what extent, and what the impact will be. The only thing that experts agree on is that action is necessary because this recovery is virtually nonexistent.
What does QE2 mean to me?
One of the most expected results of QE2 is a weaker dollar. In fact, we've already seen the dollar weaken given all the TALK about QE2. While a weaker dollar helps make our exports more attractive to foreign buyers because it makes our products less expensive to purchase (if it's less expensive, they will buy more), it makes imports more expensive. Expect to pay more for things like French wine, Dutch cheese, German cars, Belgian chocolates, Scottish cashmere sweaters, and overseas vacations, for example.
Are there other ways this will affect my purchasing power?
When the dollar falls, commodities -- from oil to gold, corn, cotton, wheat, sugar, and more -- often rise because they become cheaper to investors holding other currencies. As speculators pour money into these goods, you pay more-- at the grocery store to the pump. On a positive note: The Fed's action will have some effect in lowering mortgage rates, and lower mortgage rates puts more money into your pocket.
Should I worry about inflation?
No doubt -- when there's more money in circulation, it's worth less. But this moderate purchase of bonds by the Fed will almost certainly be beneficial because while quantitative easing brings with it the risk of inflation (currently, it's precariously low; in fact, it's at a level that is considered below optimal), it also removes deflationary risk. Preventing deflation -- a widespread drop in prices, wages, and the values of stocks and homes -- is a much higher priority.
Is it going to be easier to get a loan?
It should. When the central bank uses its new cash pool to buy financial assets, the institutions selling these assets (such as commercial banks) then have a greater money supply. With more cash on hand, banks should start lending to you (and businesses, for that matter) again. The operative word is should because banks' current stinginess (They're sitting on piles of money) has little to do with the size of their reserves. Despite historically low rates, banks aren't making loans because they don't think you're worthy of lending money to, and they're afraid they're not going to be paid back.
How is this going to help me find a job?
Flooding the economy with money -- and pushing down interest rates as a result -- usually results in corporations accessing more capital for additional investment, and that means adding to the payrolls. But in the current environment, are corporations really going to use this money to bring in new hires when they've become so accustomed to having one person do the work of three? Doubtful. After all, it's not like companies -- flush with cash -- are delaying investments because rates are too high. In the meantime, assuming U.S. exports rise, and Americans buy more U.S.-made goods, there could be some hiring, but the creation of millions of jobs would require strong economic growth overseas and a big shift in exchange rates.
What does quantitative easing mean to my investments?
The last round of easing triggered a huge stock market rally. Equity prices will likely rise again (That's why you're seeing investors put money into stocks and other assets) because quantitative easing compels investors to assume more risk; move their money out of safe, low-yielding investments and into other securities. Conversely, quantitative easing means lower rates on things like money market accounts and certificates of deposits.
What if this fails?
If no one spends or invests this money productively, the economy could end up trapped in a downward spiral marked by low growth and high unemployment -- for a decade or more.