The Federal Reserve announced a new round of bond-buying Wednesday to lower long-term interest rates to boost the economy. A rundown of the key issues:
Q: What is quantitative easing, or QE?
A: It’s the electronic equivalent of starting up the Fed’s printing presses to create money for buying financial assets in the market — in this case, long-term U.S. Treasury bonds. Buying bonds pushes down their yields and the interest rates across the debt markets that are closely tied to U.S. Treasury rates.
Q: How does the Fed expect QE2, as it has been dubbed, to influence the economy?
A: Lower borrowing costs should help some homeowners refinance, even if many others don’t qualify because of weak credit scores or diminished home equity. It also should help businesses that can qualify for loans through cheaper credit, though larger corporations already can access money at cheap rates. The Fed figures that buying up government debt, in theory, should push investors into riskier assets — such as stocks and corporate bonds — and raise their value. It also will tend to weaken the dollar, helping U.S. exporters be more competitive in overseas markets.
Q: Why is the Fed planning another round of QE?
A: Even though the Fed has been holding short-term interest rates near zero since December 2008, the economy remains weak. The Fed is falling short on its two primary mandates: Unemployment, at 9.6 percent, is well above “maximum sustainable employment,” and inflation is running below what the Fed considers to be “price stability,” an informal target of 1.75 pecent to 2 percent.
Q: What are the risks?
A: No one, inside or outside the Fed, knows the precise effects, or the unintended consequences, of more bond- buying. Giving investors incentives to seek higher yields in riskier assets raises the likelihood of creating asset- price bubbles. The low rates of 2003-04 are believed by some analysts to be a major factor in creating the housing bubble, though Fed Chairman Ben Bernanke doesn’t think so. At some point — well before the economy has completely recovered — the Fed will need to withdraw all the money it’s printing now to avoid a surge in inflation down the road. Some investors don’t believe the Fed will be able to do that quickly enough and fear that inflation will result.
Q: What effect would QE have on the dollar and overseas economies?
A: Printing more money tends to push down the value of the dollar. While that would tend to help U.S. exports, it also risks pushing up the price of oil and other commodities, threatening an inflation surge that could be difficult to stop if the economy picks up. The dollar already has fallen substantially.
