The much talked about and discussed second part of quantitative easing (QE2) will come to an end in June this year. This leaves us with a thought as to whether QE2 really achieved its aim for which it was launched? Besides, it also raises a question as to how the end of QE2 would affect different markets such as commodities, and equity (especially the emerging markets). But before proceedings with all these questions, another important point that needs to be looked at is in case QE2 fails in lifting the global economy, can we expect an announcement of a third series? Going forward in the report, we would certainly figure out the answers for these questions but first, let us explain the background as to why the quantitative easing was needed in first place?
In the aftermath of one of the worst economic crisis since the great depression in US, it was very important for the Federal Reserve Bank (Fed) to elevate the sagging economy. Beginning the recovery process, it used the normal technique and lowered interest rate to boost the economy. However the move to slash rate from 5.25 per cent at the end of July 2007 to virtually zero at the end of December 2008 did little to perk up the economy. Moreover these were the short term rates and targeted towards managing the short term interest rates and so, did not have the desired effect on long term interest rates. Therefore in order to further ease the stance of monetary policy, the Fed purchased substantial quantities of assets with medium and long term maturities to manage interest rates of more than one year. This purchase of assets in a more simplistic term is known as debt monetizing and as an euphuism it came to be known as quantitative easing.
So, it would be apt to say that QE is nothing but a large scale purchase of assets by the central bank. These assets include but are not limited to Treasury securities, mortgage-backed securities (MBS) etc and help in keeping the short to long term interest rates at a lower level. When the Fed buys an asset, it reduces its supply of those securities from the market and because of that its (bonds) prices rise and the yield falls. It is further populated to other securities of similar nature and hence helps in keeping interest rates low. All these discourages saving and inspire firms to invest more, consumers to spend more, banks to lend more and as a results, the economy is expected to come back on the growth track.
Sounds like a perfect dose for an ailing economy to come out of illness!
However if we look at the real picture, the impact of this is not visible. On the contrary, it actually resulted in some unexpected consequences. According to the US Labour Department, during QE2 the number of full-time workers went up by just 700000, from 111.8 million to 112.5 million. Even if we look at the housing market, the situation is no better and as per the National Association of Realtors, the average price of an existing home was USD 177300 in August just before QE2 and currently it is USD 163700, down by eight per cent. The economy that was supposed to fire on all cylinders due to QE2 also faltered and economic growth slowed down from 2.6 per cent at the start of QE2 to just 1.8 per cent for the quarter ended March 2011. So it seems that QE2 majorly failed in achieving its objective of uplifting the sagging US economy and thereby provided a fillip to the global economy. So, what happened to this freshly created money and where did it go?
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