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QE3: Fed's 3rd dose of quantitative easing?

American flag flying over the capitol building
Highlights
  • Poor economic data have once again caused worries about the economy.
  • The phrase "double-dip recession" is again becoming a water-cooler topic.
  • Another round of Treasury purchases to boost the money supply is possible.

A barrage of poor economic data has once again put worries about the economy front and center. Those worries have grown by the day, fueling what is now officially a stock market correction but what looked a whole lot like a panic on Aug. 4, 2011, when broad market indicators dropped nearly 5 percent.

Optimistic forecasts of economic growth of 3 percent to 4 percent in the second half of 2011 are being recalibrated, and the phrase "double-dip recession" is again becoming a water-cooler topic.

All of this ramps up pressure on the Federal Open Market Committee to trot out another round of economic stimulus. Whether they make such an announcement at today's meeting or wait for another venue such as last year's announcement by Federal Reserve Chairman Ben Bernanke at the Fed's annual gathering in Jackson Hole, Wyo., is something that's likely still in the discussion phase. However, the Fed cannot sit and watch the economy unravel, and will ultimately feel compelled to do something.

But exactly what? And will it work?

The most recent attempt, a program of purchasing government bonds, known as QE2, for a second round of "quantitative easing" to increase the money supply, successfully pushed the stock market and commodity prices higher and vanquished the threat of deflation. But it did little else to lift the economy. Nonetheless, another round of asset purchases is certainly possible, even if the "trade-offs" are "less attractive" as Bernanke said in his April 27 press conference, hinting at the inflationary consequences such a move could have.

In a QE3, the FOMC could cut the interest rate paid to banks with excess reserve balances at the Federal Reserve as an incentive to push this money back into the economy. But in a weak economy, this won't jump-start either the demand for loans or supply of available credit.

Or, the Fed could pledge to keep the target range for the federal funds rate low for a specified period, instead of using the vague "for an extended period" to frame the time period. The fact that interest rates will remain low is evident by looking at the weak pace of economic expansion and uninspiring level of job growth. This would be nothing more than a symbolic move and likely yield little or nothing in tangible results.

Regardless of which option or options the Fed chooses for QE3, the Fed cannot create jobs. They just ensure monetary conditions such as interest rates and inflation are favorable to job creation, and that hasn't been enough.

Some additional Fed stimulus appears inevitable. Whether it will be effective remains to be seen.

 

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