The U.S. economy had been in the doldrums for more than two years when Ben Bernanke, Chairman of the Federal Reserve, announced a new economic stimulus plan in November 2010. He called it “quantitative easing,” and because it was similar to a program adopted a year earlier, it was dubbed “QE2.”
Will QE2 work? Why does Bernanke think it will succeed? What was learned from earlier programs that will be reflected in this second round of Fed-based economic stimulus?
To begin, it’s important to understand what QE2 is. The program is a stated policy by the Fed to purchase $600 billion in U.S. Treasury bills over a period of about six months – roughly December 2010 through May 2011. The gradual purchase of the Treasury bills is designed to keep interest rates low and thus spur the economy by encouraging businesses and people to borrow money. When people borrow money, they usually do so with the intention of spending it fairly quickly, whether for a personal purchase (home, car, etc.) or a business investment. Either way, their spending will create more spending, and thus raise overall economic activity. At least, that’s the goal.
One of the Fed’s roles is to keep interest rates at attractive levels, relative to the strength of the economy and the rate of inflation. When the economy is weak, the Fed engages in “easing” the availability of money. It has been doing this during the recession, and evidence is clear that the easy-money policy helped to make the recession less severe than it would have been otherwise.
In 2010, the economy showed signs of strength, as sales increased and new jobs were created at a slightly better pace than in 2009. But, as everyone knows, the growth was far from adequate to help the more than 15 million people who are seeking jobs. That’s why QE2 will act as a booster shot to help to sustain that momentum from 2010 and give businesses extremely low interest rates for investing in their future profitability.
Past history suggests that the policy will work. Numerous times over the last 30 years the Fed has reduced interest rates in order to spur investment, the economy, and jobs. And it has worked every time. Sometimes, the Fed has done it through quantitative easing, and sometimes it’s used other programs, such as reducing the rate it charges banks to borrow from it. Regardless of how it’s been done, businesses have responded the same way each time: taking advantage of “cheap” loans. In fact, the only problem that has occurred is when demand for borrowing rose so rapidly in the wake of an easing policy that interest rates surged back up. That doesn’t seem likely in the currently tepid economic environment.
Everyone expects that the U.S. will climb out of the recession, but of course, no one knows when it will happen. Timing (and everyone’s expectations about timing) is a crucial factor. If businesses sense that they will soon have opportunities to sell more stuff, then they will make investments (in people, equipment, and supplies) so that they can provide that stuff. If they feel that the strength of the economic recovery is still a few years away, then they will be cautious, even with QE2. This doesn’t mean that nobody will borrow money today, but just that the benefits of QE2 won’t be as strong or as immediate.
But investors also understand that QE2 represents the goverment’s commitment to help the economy. The government – Congress, the President, the Fed, state governments, and so on – will not stand idly by while the U.S. drops into another recession or even a depression. The government will enact policies to encourage growth and hiring. In this way, the massive scale of QE2 will generate confidence in and of itself, by showing that support will continue. And that commitment, coupled with the genuine opportunities that are occurring as the economy gains strength, will make QE2 successful in stimulating the economy in 2011.