To QE or not to QE?

LONDON, September 17, 2012 /PRNewswire/ --

So there's not enough money in the economy, unemployment is far too high, interest rates are at near 0%, everyone is dejected and conventional measures have run out of ammo, "time for another round of Quantitative Easing", some may say. But what exactly is Quantitative Easing (QE) and why should we care?

Investopedia defines Quantitative Easing as "a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market", or in plain English, a policy designed to directly inject more money into the economy. No-one (that we know of) wants to stay in recession, and although controversial, Quantitative Easing is a policy designed to haul economies out of sticky situations when all other attempts fail.

So how does Quantitative Easing work? The central bank generates a substantial amount of money and pumps it into the economy through purchasing assets from financial institutions. This gives financial institutions more money, which are in turn, more willing to lend money. Increased lending to businesses and consumers will encourage people to go out and spend more on goods and services, and businesses to expand and hire necessary staff. This in theory pumps more money into the economy and helps stimulate growth.

In the US there had already been two rounds of Quantitative Easing, and yesterday everyone was on Fed watch with ears tuned to the voice of Federal Reserve Chairman Ben Bernanke to see if he would announce a third (QE3). "What's this got to do to with us?" you might think, but with the world's largest economy, any announcement of QE3 in the US would likely have a huge impact on financial markets and economies across the globe.

The trillion dollar question is does Quantitative Easing work? Most people would cautiously answer "yes" (although we have no idea how bad the situation would be without it). Results from QE1 and QE2, where the Fed pumped over $1.5 trillion dollars into the US economy to support the housing market, saw the 30 year mortgage rate drop to 5% a year later, and now sitting at just above record lows.

With an economy that is still showing some signs of life, an inflation rate that is hardly catastrophic and the announcement coming so close to the Presidential elections in November, there are reservations across the Atlantic on whether the US really needs QE3 and if now is the right moment.

Quantitative Easing is a highly controversial and risky policy, as would be the case with pumping such a large amount of money in the economy. Many see it as a short-term fix to plug a leaky economy, an economy that will leak again as soon as the plug is removed.  Like one and two before it, QE3 has its critics and the impact not just in the US but the global economy as a whole will be played out over the coming weeks, months and years. Can QE cure the crisis? That is the question.

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SOURCE Capital Spreads