Sail, Ho!

What is QE3?

No, it’s not a luxury-liner. QE3 is shorthand for quantitative easing, an unconventional approach to monetary policy that the Fed is using to influence the economy. They implement this by buying bonds from commercial banks in order to add to the money supply. Usually, the Fed directly targets interest rates; but with short-term rates at zero, they have to focus on the money supply instead

It’s called QE3 because this would be the third round of reserve addition for the Fed since the Financial Crisis began in the summer of 2007. In late 2008, as major banks were failing and the money market was seizing up, the Fed purchased about $1 trillion of bonds. In late 2010 and early 2011, as the Euro-crisis threatened to spread, the Fed purchased another $600 billion in notes.

Now the Fed is widely expected to embark on a third round of asset purchases. Advocates of quantitative easing note that the Fed has, by law, a dual mandate: to minimize inflation and maximize employment. Well, the first goal is being met: inflation has been well below 3% for over a decade, and is now running under 2%. But with employment still 5 million jobs below its peak in 2007, there’s no way we’re anywhere close to full employment.

So Chairman Bernanke feels the Fed needs to do something, and that something right now is likely to be adding directly to bank reserves. Of course, if the banks just sit on those reserves and the money doesn’t get out into the economy, it doesn’t stimulate anything. And there is some evidence that that’s what’s happened since 2008. But it did convince market players that the Fed was engaged–so measures of stress in the global financial system have gone down.

Still, like the eponymous ocean-liner, QE3 is a vessel, not a destination. The goal is economic recovery. When or whether we ever arrive is still an open question.

Douglas R. Tengdin, CFA
Chief Investment Officer
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