Update: Quantitative Easing: What is the Federal Reserve Really Doing?

publication date: May 21, 2012
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Update May 21, 2012: After the Federal Reserve completed its second round of quantitative easing (QE), explained in my previous article below, various pundits have speculated whether their would be a third round of QE because of further expected economic sluggishness. With the recent resurgence of problems in the EU and a slowing of U.S. economic numbers, speculation is growing that a third round of QE is coming. 

A reader sent me a recent question about QE which highlights a topic I often see put forth by pundits and the media: "...you state that the Fed is not printing a ton of money. However the accompanying graph showing percent change in the money supply reveals increases of as much as 10% or more in some periods over the previous year. That seems like a lot. Doesn't this continuous expansion reduce the value of all money?"

The short answer is not really. The money supply graph below uses the M2 measure of money supply. This definition of money supply includes "...the sum of currency held by the public and transaction deposits at depository institutions...plus savings deposits, small-denomination time deposits (those issued in amounts of less than $100,000), and retail money market mutual fund shares," according to the Federal Reserve.

Retail money market assets and bank deposits, could increase for example, if individuals decide to hold more cash. Also recognize that the demand for these highly liquid assets can come from folks around the world so increased demand for the U.S. dollar during times of stress can lead to the growth of M2. Changes in money supply are complicated and perhaps the subject a future article.

 

During and after the 2008 financial crisis, I've written numerous articles about the Federal Reserve, Fed Chairman Ben Bernanke, and the actions the Fed has taken. I've explained their most important actions and discussed the expertise and qualifications of Chairman Bernanke. Many pundits interviewed on financial cable television programs and website pontificators have used the Federal Reserve as a punching bag, blaming them for various economic problems including the 2008 financial crisis. Despite the rebounding economy and stock market, some of the critics have gotten even more vocal of late blasting the Fed for the $600 billion "quantitative easing" program begun late in 2010.

More often than not, the most vocal critics, who typically and erroneously claim to have predicted the 2008 crisis, have an agenda to appear smarter than everyone else including the Fed. Some of these pseudo-experts are precious metals hucksters and thus like to claim that the Fed is going to cause hyperinflation which will impoverish you unless you buy gold, silver, etc.   

In one popular video which has millions of YouTube views, the author claims/states the following using goofy cartoonish characters:





Don't Confuse Me With the Facts


While it's stunning in and of itself that this video has been watched about 4 million times in just two months, what's even more amazing and disturbing to me is how many mainstream media and other websites and outlets have promoted and recommended the video with little if any effort made to fact check and reality check its contents. I will do so now, in part, to set the record straight and to advance your understanding of what quantitative easing really is and why the Fed is doing it. Let's go through the video's main assertions point by point:


FRED Graph






FRED Graph

Now, I haven't seen much questioning of the background and agenda of the person behind this fact-challenged YouTube video. Its creator is Omid Malekan, who is referred to in some articles as a "30 year old real estate manager." The Iranian born Malekan has no discernible background or expertise in the subject matter discussed in the video which helps explain why nearly every statement in the video is wrong.

Quantitative Easing (QE) Explained


In various speeches and selected interviews, Fed Chairman Bernanke has explained QE. Here's one fairly plain English explanation (note: "central bank" means the Federal Reserve) that Bernanke made during the height of the credit crisis:


"Quantitative easing can be thought of as an expansion of the central bank's balance sheet with no intentional change in its composition. That is, the central bank undertakes more open market operations with the objective of expanding bank reserve balances, which the banking system should then use to make new loans and buy additional securities. However, when credit spreads are very wide, as they are at present, and the credit markets are quite dysfunctional, it becomes less likely that new loans and additional securities purchases will result from increasing bank reserve balances.

In contrast, credit easing focuses on the mix of loans and securities that the central bank holds as assets on its balance sheet as a means to reduce credit spreads and improve the functioning of private credit markets. The ultimate objective is improvement in the credit conditions faced by households and businesses. In this respect, the Federal Reserve has focused on improving functioning in the credit markets that are severely disrupted and that are key sources of funding for financial firms, nonfinancial firms, and households."


In addition to explaining QE in this speech, Bernanke also delineated that in order for QE to work, the credit markets must be healthy as they are now but weren't in late 2008 and into 2009.

 

 


 

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Copyright Eric Tyson, 2008 - 2023 all rights reserved.

Eric Tyson is the only best-selling personal finance author who has an extensive background as an hourly-based financial advisor and who does not accept speaking fees, endorsement deals or fees of any type from companies in the financial services industry or product or service providers recommended in his articles, books and his publications.


 
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