The Federal Reserve’s Third Quantitative Easing: QE3 Sets Sail

November 1, 2012

To fix a struggling economy, the Federal Reserve has pursued many strategies aimed at dealing with the financial crisis, says Robert McTeer, a distinguished fellow with the National Center for Policy Analysis.

  • The first round of quantitative easing occurred around 2008 when the Fed had reduced the federal funds rate to a zero-to-quarter percent range, allowing the Fed to purchase Treasuries and other assets.
  • In 2010, the Fed initiated the second round of quantitative easing in which $600 billion more in Treasuries were bought.
  • The Fed's next prescription came to be known as Operation Twist, in which longer-term Treasuries were, with an equal amount of shorter-term Treasuries, sold in order to put downward pressure on long-term rates without increasing total assets.

The latest effort is referred to as QE3, or the third round of quantitative easing.  The Fed said it would buy $40 billion of agency mortgage-backed securities per month until the unemployment rate declined with the goal of pumping more liquidity into the economy to reduce mortgage interest rates.

Financial markets welcomed QE3 while many critics argued that printing more money would trigger hyper-inflation and a collapse of the dollar. However, those fears are misplaced. Because of the financial crisis, banks hold on to most new reserves, which halts the money creation process. Thus, because the money is not being spent, there is no risk of inflation or a weakening of the dollar.

While this is good news, the money not being spent means that the effect that QE3 has on the economy is smaller than intended. However, those excess reserves are being held for precautionary purposes. If the Fed didn't supply the banks with additional reserves, then the banks would respond by reducing lending and investing. In the Great Depression, for example, the Fed sought to mop up what they deemed to be excess reserves held by banks which made the depression worse.

Source: Robert McTeer, "The Federal Reserve's Third Quantitative Easing: QE3 Sets Sail," National Center for Policy Analysis, November 1, 2012.

 

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