Easing and How the Implications of the

¶ … easing and how the implications of the Federal Reserve policy will affect the financial markets moving forward Quantitative easing is one of the tools of the Federal Reserve and other central banks around the world to affect the money supply of the nation. Quantitative easing is often called the process of 'making money' out of nowhere (Q&A: Quantitative easing, 2012, BBC News). Traditionally, during periods of economic contraction, the Fed tries to stimulate the economy by lowering interest rates.

It also lowers the discount rate, or the rate at which member banks can borrow from the Fed. The lower the rate, the greater the incentive for both consumers and member banks to borrow funds, and increased borrowing leads to increased spending. As consumers and businesses spend more, the economy gets stimulated by the upturn in consumption, more workers are hired, and eventually the recession abates and the Fed can increase rates once again. However, this scenario does not always transpire so neatly.

The need for quantitative easing was particularly acute during the last recession, given that interest rates had already been effectively lowered to zero. "Central banks tend to use quantitative easing when interest rates have already been lowered to near 0% levels and have failed to produce the desired effect" (Quantitative easing, 2012, Investopedia). This was the case before the election of 2008. Despite the low interest rates designed to stimulate the economy, consumers were afraid to spend because of worries about losing their jobs.

Consumers were also severely overleveraged because of the fallout from the housing market, and homes are usually Americans' primary assets. Because of the high default rates, banks were reluctant to lend money to consumers. In such a scenario, quantitative easing is required. To create an influx of liquid cash into the economy and encourage spending, the Fed will buy back Treasury Bonds and other government securities. "Quantitative easing increases the money supply by flooding financial institutions with capital, in an effort to promote increased lending and liquidity" (Quantitative easing, 2012, Investopedia).

In the United Kingdom during the same time period, a particularly aggressive policy of quantitative easing was deployed for similar reasons because of historically low interest rates that did not stimulate the economy. "A Bank of England report into the effect of the first round of QE suggested that the measure had helped to increase gross domestic product by between 1.5% and 2%, indicating that the effects of the programme had been 'economically significant'" (Q&A: Quantitative easing, 2012, BBC News).

"The major risk of quantitative easing is that, although more money is floating around, there is still a fixed amount of goods for sale. This will eventually lead to higher prices or inflation" (Quantitative easing, 2012, Investopedia). There is currently pressure upon the Fed to stop.