A much-anticipated second round of quantitative easing from the Federal Reserve is expected this week. In a move known as “QE2,” the Fed is expected to buy Treasury securities to flood money into the economy, make it easier to borrow and spend, and reduce the likelihood of deflation. Some experts think QE2 is a risky move that could weaken the Fed and trigger inflation without having the desired effect.
QE2: Money from nothing
The Federal Reserve Open Market Committee will meet to discuss monetary policy Tuesday while the country is conducting midterm elections. The Fed has been waiting until after the election to announce additional measures to stimulate the economy. Most experts, traders and investors expect the Fed’s next move to be another round of quantitative easing. Fed chairman Ben Bernanke has said that deflation is emerging as the biggest threat to economic recovery. QE2 is an attempt to prevent deflation. By buying Treasurys, the Fed is essentially creating money from nothing and infusing it into credit markets. In theory, interest rates will stay low, lending will increase, and the economy will be stimulated.
QE2 the Fed’s only remaining option
The first round of quantitative easing began when the economy collapsed at the end of the Bush administration. The Fed purchased more than $1 trillion in bad home loans that were packaged and sold as securities that no investors would touch. Quantitative easing was considered effective in slowing the economy’s decline. The rebound has yet to happen, however, with an anemic 2 percent growth rate in the third quarter. QE2 may be the only arrow left in the Fed’s quiver.
QE2 a ‘dangerous gamble’
Quantitative easing comes with high risk, and some are warning that runaway inflation could be the consequence if the Fed pulls the trigger. Thomas M. Hoenig, president of the Federal Reserve Bank of Kansas City, recently called QE2 a “dangerous gamble” and a “bargain with the devil.” But grandstanding politicians demonizing government spending have deprived the Fed of fiscal policy in the form of economic stimulus. Economist James K. Galbraith told the New York Times that government stimulus would work. He said quantitative easing would do nothing but flood banks with more cash they won’t lend.