...as Fed steps in again

Q.WHAT IS QE2?
A. It is the Federal Reserve’s second round of quantitative easing after its initial asset purchasing programme of $1.7 trillion started during 2009 and finished in March this year. This time, the Fed has announced a smaller programme: it plans to buy up $75bn’s worth of assets each month until June next year, for a total of $600bn – although it could adjust its stance in response to economic data. In order to make these purchases, the Fed essentially creates or “prints money”. The latest announcement is in addition to $250-$300bn of maturing debt from its last round of QE, which the Fed has said it plans to reinvest.

Q.WHY IS THE FED DOING THIS?
A. With interest rates at near zero, the Fed has run out of normal monetary policy tools with which to stimulate the US economy. QE is an attempt to lower long-term interest rates further and encourage lending and demand. The hope is that this will bring down the US’s 9.6 per cent unemployment rate and head off deflation.

Q.HOW IS IT SUPPOSED TO WORK?
A. It is not entirely clear. Last time, the programme worked in part by buying up toxic mortgage securities and taking them out of the market. But this time, the Fed is only buying bonds. Some argue that by pushing down US treasury yields, QE will make alternative assets more appealing and lower the cost of borrowing generally. Yields on 10-year treasury notes declined slightly yesterday to 2.57 per cent from 2.58 per cent yesterday, reflecting the extent to which the market had already priced in the announcement. In addition, QE affects exchange rates because it increases the supply of dollars and effectively depreciates the currency, making American exports more attractive. The dollar index slid to 76.4 from 76.7 yesterday.

Q.WHAT ARE THE RISKS?
A. The main criticism is that QE is likely to be ineffective while having numerous downsides. There is the possibility of a spike in inflation if the recovery gathers pace, which could destabilise the US economy and get out of control. In addition, critics say that creating money artificially pumps up asset prices, creating bubbles that will at some point burst and damage growth. Abroad, other countries see QE as a competitive devaluation, increasing the risk of currency wars and retaliation with tariffs.