Home > Business & the Economy > Quantitative Easing: Out of Nothing

Quantitative Easing: Out of Nothing

Quantitative Easing is a monetary policy used by a nation’s central bank to stimulate the economy.  The central bank buys its own government’s bonds on the open market, thereby increasing the money supply. This additional money is supposed to stabilize or lower interest rates, and make it easier to borrow money.

So where does the central bank get the money?  It prints it.

Last week, the U.S. Federal Reserve (the Fed) decided to engage in another round of quantitative easing.  Over the next eight months, the Fed will purchase $600 billion of US government bonds. This will be in addition to the $1.7 trillion of U.S. bonds the Fed purchased between January 2009 and March 2010.  Thus, by the end of June, the Fed will own $2.3 trillion of U.S. debt. The Fed is expected to print up to $900 billion of new money to fund these purchases. 

In a Wall Street Journal article defending the decision, Fed Chairman Ben Bernanke has justified the action as part of normal monetary policy.  He stated that “We see an economy which has a very high level of under utilization of resources and a relatively slow growth rate.”

However, quantitative easing is not without risks.  A spike in inflation is one of the primary concerns.  Printing money creates assets ex nihilo (out of nothing).  Since no additional value is created, pumping more money into the system devalues the existing dollars, which often leads to inflation.  The ability to print money ex nihilo is why the U.S. government will never go bankrupt.  All it needs to do is print more money to cover its debts.  However, this technique usually results in hyperinflation.  History is full of nations that have inflicted financial ruin on themselves by using this type of monetary policy.

Apparently the Fed believes that a lack of liquidity is the cause of anemic economic growth.  I’m not an economist nor as smart as the Chairman, but something doesn’t seem to add up.  We’ve been hearing for months that banks and corporations are currently sitting on approximately $2 trillion of cash. Their reluctance to invest this money is hindering the economic recovery.  If there is already $2 trillion of excess cash, what is the benefit of creating $600 billion of additional liquidity?  Lack of demand and uncertainty of the future seems to be a greater hindrance to economic growth than a lack of money.

The first round of quantitative easing didn’t seem to have much of an effect on the economy. Time will tell if Chairman Bernanke is correct in his assessment of round two.  Hopefully it does as he expects and the economy grows.  More importantly, let’s hope it doesn’t backfire and spark a significant rise of inflation.  If so… we could easily return to the days of stagflation in the late 70’s and early 80’s.

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