Everywhere you turn in the financial media lately, you hear
people talking about "quantitative easing or QE ".
Well, here is it being simple put.
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It's one of the most impressive financial phrases out there —
impressive for the distance between how boring it sounds and how dramatic it
actually is.
It means creating massive amounts of money out of thin air
with the hope of getting the economy back on track ( printing money ) .
Economists — at least some economists — believe that when you
want to improve the economy you need to get more money out there, circulating
around. The problem is, there are only a few ways to do this:
One way:
Have the government spend money by, say, paying
people to build roads or install solar panels. That would get money into
people's pockets.
But we already did that, with the 2009 big stimulus —
and it's a politically unpopular idea at the moment, so Congress isn't about to
do it again.
Option two:
The Federal Reserve can cut interest rates, which
makes it cheaper to borrow. So people borrow more, buy more, build more new
things.
But we already did that, too. The Fed lowered interest rates
all the way down to zero. Can't go any lower.
For almost all of modern economic history, policy makers have
used those two tools — government spending or Fed interest rate cuts. That's
it. But with this financial crisis, for the first time in U.S. history, those
two tools won't work.
Enter quantitative easing, an idea the Fed is borrowing from
Japan, which used it a decade ago when it had a similar problem.
It works like this.
A big bank — Bank of America, say — has $50 billion in
government bonds. They'd sell those bonds if anyone would pay enough for them,
but nobody is willing to pay that much. So the bank just holds on to them.
With quantitative easing, the Fed comes along and says,
"Hey, Bank of America, we'll buy those bonds for a little more than anyone
else is willing to pay." Bank of America says, "OK, great, send us
the money."
This is where the Fed gets to use central-bank magic. They
pay for that $50 billion purchase in new money. They just invent it. That's
what the Fed — but nobody else — gets to do.
So now Bank of America has $50 billion they need to do
something with. The Fed is hoping that Bank of America will decide to lend that
$50 billion to companies and people to invest or spend. That stimulates the
whole economy.
It sounds great. Create new money, get it out there, everyone
wins. But — of course there's a but.
Nobody really knows if this works. It's still really
controversial among economists. It's only been tried a few times and, as in the
case of Japan, hasn't had the greatest results.
While the economy is still this bad, the Fed really might
only have two options: Do this as a desperation move, or do nothing.
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