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What is Quantitative Easing?

With the US economy in consistent decline, many investors are awaiting the announcement of “QE3,” or the third round of quantitative easing by the Federal Reserve. This term is now thrown around like it’s commonplace, but it really only came into widespread use after the financial crisis struck in 2008. Here’s a simple guide to what it means, and what the difference is between QE1, QE2, and all future QEs.

Typically, the Federal Reserve dictates monetary policy by manipulating the target of the federal funds rate. This is the interest rate banks receive to loan other banks money to meet their minimum reserve requirements, as dictated by the Fed. The federal funds rate influences the prime rate, which affects the cost of borrowing from mortgages to credit cards.

As the 2008 recession unfolded, the Fed lowered the federal funds rate to near zero in hopes that cheap borrowing costs would help stimulate the economy – but it didn’t work. Since the Fed can’t realistically set rates any lower than zero, many thought they were out of firepower. Instead, they introduced quantitative easing.

Effectively, QE is a fancy term for printing lots of money. The Fed uses this money to buy securities or government bonds, thereby putting the new cash directly into circulation.

In QE1, which Fed Chairman Ben Bernanke called “credit easing,” the Fed bought over a trillion dollars in toxic mortgage-backed securities. This allowed big banks to remove these worthless assets from their balance sheets, which the Fed hoped would the encourage the banks to lend out money again and ease the credit crunch. QE1 lasted until March 2010.

As the economy continued to stumble, the Fed began a second round of QE in November 2010 by buying loads of Treasury bonds. The goal was to push down long-term interest rates, thereby encouraging home-buying and other long-term capital investments. This also puts money into banks and credit institutions, as by law, the Fed cannot buy bonds directly from the Treasury. This program was ended in June of 2011.

As our readers well know, the economy is still listless and unemployment remains high. It’s unclear what QE3 will look like, though few doubt there will be one. Peter Schiff often says that there will be more QEs than Rocky movies. What is certain is the price of gold and silver has jumped with each additional action by the Fed.

For a more lighthearted overview of this topic, watch the famous video Quantitative Easing Explained.

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