The Sinking of the QE2?

On November 3^rd, 2010, Ben Bernanke, the Chairman of the United States Federal Reserve, announced a planned $600B buy-back of US long-term treasury securities deemed “Quantitative Easing 2” or “QE2.” With the announcement of QE2, the total amount of quantitative easing will reach an estimated $2.7T by the end of the third quarter of 2011.[1]The looming question that remains is whether or not QE2 is working – more specifically, whether it meets its intended goal of increasing lending and borrowing to spur overall economic growth.

Fundamentally, quantitative easing increases the money supply by purchasing large amounts of securities, in this case government treasury bonds. With the excess capital that floods into the marketplace, financial institutions will then have more capital available to lend, thus increasing borrowing and spending in the greater economy. Quantitative easing is usually employed only after all other policy tools have been employed: open market operations, the discount rate, and reserve requirements. While quantitative easing may sound like the perfect answer, it does come at the very steep cost of inflation.

In order to determine whether QE2, a second attempt at a last-stitch effort, is working, we must look to and speculate upon key economical metrics.  Between November 3^rd when the plan was announced and November 6^th, the S&P 500 jumped 101 points or 8% from 1,185 to 1.286.[2] By November 17^th, the S&P 500 was down to 1,175, but by December 3^rd, reached 1,225. It is important to note that the market’s reaction was immediately bullish. If one holds that the markets are efficient, the information was absorbed immediately, and QE2 was effective. However, according to Dr. Tientip Subhandij of the Bangkok Post, “…the impact [quantitative easing] has on markets and the economy – can be so long that we may not even notice whether it’s working at all.”[3] Since the financial institutions that are left to circulate the additional capital in the market cannot be identified or tracked, we will not know if and when the lending has actually occurred, and what the overall impact of said lending is.  While there is no surefire way to attribute economic revival to a particular Federal Reserve policy measure, we do know that the economy has by no means rebounded since December 3^rd.

QE2 might be more political than financial; the American people want to know that the government is trying something to ease their pain.  But, at the end of the day, quantitative easing is simply exchanging one evil for another – increasing the supply of money at the cost of inflation. One might go so far as to call it reckless disregard by trying to use limited governmental regulation far too late. The economic downturn was without a doubt caused in part by a lack of regulation, but this time, the Fed is too late to pick up the pieces, and QE2 is certainly not working.