If QE1 seemed to spur the markets and QE2 may still have helped, is QE3 really a good idea?
Quantitative easing, or QE, is one of the tools the Federal Reserve uses to achieve its dual objectives of maintaining full employment and keeping inflation under control.
With the announcement of the third wave of QE, the Fed is saying the U.S. economy is still relatively weak, inflation is not a near-term concern and economic forces outside the U.S. are not sufficiently supportive to spur the desired increase in U.S. business activity.
According to the Fed's recent statement about its most recent QE activities, the Fed will purchase an additional $40 billion of agency-backed residential mortgage securities each month.
By purchasing these residential mortgage-backed securities in the open market, the Fed intends to further decrease longer-term interest rates. Lower longer-term interest rates should enable residential mortgage borrowers to enjoy lower borrowing costs. Any other entity in need of borrowing money should also benefit from lower interest rates.
Another important announcement from the Fed is its intention to keep the target level for federal funds borrowing at the current range of zero to 0.25 percent through at least mid-2015.
Given this stated policy, short-term interest rates are expected to remain very low for several years.
Lower interest rates have some negative effects, however.
Anyone investing savings in a fixed income asset will receive a lower interest rate. Financial institutions such as banks, pension plans and insurance companies, which invest for the benefit of clients and policyholders, will earn a lower interest rate on future investments in fixed-rate assets.
This results in lower interest rates credited to purchasers of bank-issued certificates of deposit, lower rates on cash held in checking accounts and savings accounts, and lower crediting rates on other financial products dependent on the general level of interest rates.
Potential negative effects of ongoing QE include spurring future inflation and deflating the value of the U.S. dollar.
While the timing and certainty of these outcomes are uncertain, the Fed will have to manage its way out of the various QE efforts very carefully so as not to create undue concern in the global financial markets.
Kirby Brown is the CEO of Beneficial Financial Group in Salt Lake City.
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