Quantitative easing, version two, is on the way. The Federal Open Market Committee (FOMC) announced Wednesday afternoon its plan to purchase $600 billion of securities and assets over the next six months.
Federal Reserve Chairman Ben Bernanke, who also oversees the FOMC, said the institution would try to stimulate the U.S. economy by making the move. Kansas City Fed Chair Thomas Hoenig was the only Fed official to dissent from the decision.
The committee explained its decision in an official statement:
“To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.”
The bond purchases are set to wrap up by the second quarter of next year. The $600 billion purchase was larger than previous estimates of $500 billion. It remains to be seen how the Fed’s move will impact inflation or the value of the U.S. dollar. Interest rates are expected to be kept at near-zero rate until 2012.
What Is Quantitative Easing?
Quantitative easing is a form of monetary policy used by the government to increase the supply of money within the economy. Central banks take this step when interest rates or the inflation rate nears zero. The Fed’s key interest rate has remained at a near-zero level since December 2008 and the rate of inflation has slowed to 0.1%. Countries that have taken this step in the past decade include Japan, England and the U.S. (in the most recent financial crisis).
According to Business Insider, the government does this by crediting itself for the amount of money its treasury created and using that money to purchase bonds and other products from banks. In theory, the increase in money supply could stimulate the economy. The fact that money is digitally created is why easing is sometimes simplistically referred to as “printing money.”
The possible downside of quantitative easing is the risk of hyperinflation. If inflation rises too fast, prices will rise quickly and consumers might not be able to afford essentials like food and other goods. Some analysts have criticized the Fed’s choice to enact quantitative easing as pointless because it might not affect the economy positively. These critics point to tax cuts as a more effective way to spur hiring and cut unemployment.
Simon Zhen is a research analyst for MyBankTracker. He is an expert on consumer banking products, bank innovations, and financial technology.
Simon has contributed and/or been quoted in major publications and outlets including Consumer Reports, American Banker, Yahoo Finance, U.S. News – World Report, The Huffington Post, Business Insider, Lifehacker, and AOL.com.