Attempts by the government to increase lending and consumer spending in the past several years have yielded dismal results despite the Federal Reserve having kept rates near zero. Faced with few other options, Fed chairman Ben Bernanke is considering quantitative easing as the next measure to stimulate the economy.

UPDATE: The U.S. Federal Reserve chose November 3 to enact quantitative easing by buying $600 billion in bonds.

Bernanke said last week in a Boston speech that further easing was a possible way to try to combat the nation’s high unemployment rate and low inflation. The most probable action by the Fed would be to enforce this monetary policy through purchases of government bonds, possibly totaling $500 billion.

What is Quantitative Easing?

Quantitative easing (QE) is a monetary policy in which central banks increase the supply of money within the banking system. Essentially, QE is implemented when central banks create money “out of nothing” by crediting their own accounts with money, which is done simply by adding in more numbers. It is also commonly known as “printing money.”

Afterward, central banks buy various financial assets such as bonds and debt-backed instruments from banks and other financial institutions. The process injects new money into circulation as banks obtain excess reserves required to hand out more loans. Once the new money is spent by a borrower, eventually it will be deposited at another bank. This bank will lend to another borrower and, again, the money will end up being deposited at another bank, thus repeating the cycle.

The power of QE lies in its ability to generate multiple deposits and loans with a single infusion of new money.

Expected Outcomes of Quantitative Easing

The primary objectives of quantitative easing are to combat very low inflation or deflation and to stimulate the economy through the banking system. Increased liquidity, which happens through the creation of new money, produces more lending and more spending. The Fed also hopes the flow of money will reach businesses, in turn creating jobs to sustain new growth across the economy.

From a global trading perspective, the diluted value of currency could drive exports as foreign countries experience an increase in purchasing power. Therefore, foreign markets that take advantage of the weaker U.S. currency could also experience growth and present a possible investment opportunity.

As with all other stimulus programs, quantitative easing does come with risks.

The risks of QE include:

  1. Higher-than-intended inflation, or even possibly hyperinflation.
  2. Not enough inflation due to shy or strict lending by banks.

Effects on the Everyday American

If the Fed achieves its desired results through quantitative easing, American consumers will see decreased spending power as inflation eventually leads to higher prices on consumer goods.

Conversely, people who have accumulated substantial savings will find that their money is worth less. Because of reduced interest rates avid savers could have difficulty trying to maintain a certain lifestyle while their money continues to devalue.

Increased lending by banks and financial institutions could benefit individual borrowers and owners of small businesses who may have had trouble trying to get a loan during the recent credit crisis. For example, homeowners would be able refinance their homes and perhaps stave off foreclosure.

Market analysts expect the Fed to announce the predicted purchase of government bonds during the next Fed meeting on November 3.

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