What is Fed's QE2, and what will it do? Experts explain in everyday English
Turning government bonds into circulating money is called monetizing the national debt.
• Quantitative easing is a euphemism for creating money out of thin air. In the vernacular, we call it "printing money," even though it really has nothing to do with the U.S. Bureau of Engraving and Printing.
• The way it's supposed to work is that the Fed buys securities in the open market, paying with a government "check." (That's how the money is created.) The sellers deposit those checks into their banks. The banks redeploy those deposits as loans to consumers and business. The money supply expands and, in turn, so does the economy.
Or so the theory goes.
• The money supply hasn't increased over the last two years from the first round of quantitative easing. The trillion-plus the Fed paid for mortgage-backed securities is still sitting in vaults as bank reserves.
"The system is clogged" is how Bob McTeer, former president of Federal Reserve Bank of Dallas, described it.
How is buying back $600 billion in U.S. bonds being cautionary? "There is a demand for fixed-debt instruments. You're able to print money and keep interests rates low. Supply and demand. The federal government will be able to sell its Treasury bonds every week, every month, because the Fed is going to be there to buy them. That creates demand for the bonds, keeps interest rates down low, for now, until those bonds come due.
"It could create inflation, OK?
"But that could be a good problem to have. If we have a little bit of inflation, hopefully that means the economy is growing again. People are making money. Businesses are expanding. The economy starts overheating a little bit.
"You would much rather have that problem to deal with than deflation.
"In the '30s, people stopped spending money. There were plenty of people in the world who still had money but they wouldn't spend it, because they were so uncertain and they thought prices were going down.
"If you put people in the position where they have no confidence and don't want to spend money, then you create a deflationary spiral, which is much worse than having to worry about a little bit of inflation.
"If we do get inflation down the road, the Federal Reserve can always raise interest rates and slow things down.
"When the Fed 'prints currency,' they use that currency to buy securities typically held by commercial banks and then those commercial banks have more currency, so they have more reserves in their vaults.
"Then banks loan that money to businesses. Businesses take the money and invest in projects. Then they spend the money, and the money comes back into the bank. The money supply grows by multiples of what the Fed's injected.
"But none of that happened over the past two and a half years.
"When the Fed printed all this currency from $825 billion to $2.3 trillion, it did not result in any increase in the money supply. In fact, it fell a little bit.
"We've been flirting with deflation for two years. That's really bad for the economy. This is a carefully engineered yet somewhat desperate attempt to get money supply to rise so that prices will rise.
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The central bank can also lend the new money to private banks or buy assets from banks in exchange for currency.[citation needed]
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