Ben Bernanke recently announced that the Federal Open Market Committee is ready to engage in a third round of quantitative easing. However, instead of offering a cap on the amount of money being added to the system, the Fed announced that it’s open ended: $40 billion a month until the economy gets going and employment picks up, and the Fed will maintain low interest rates out through 2015.
With QE3 underway, your finances are likely to be affected. Understanding what quantitative easing means can help you make better long term financial decisions, and prepare your money for what might be coming.
What is Quantitative Easing?
There are a number of tools that policymakers have at their disposal in order to try and boost economic activity. One of the most common is to lower interest rates. You lower interest rates, and debt becomes cheaper. More people borrow to buy stuff, because they can “afford” it, and economic activity increases. However, the Fed’s benchmark rate has been near zero for years, so it needs to do something else.
Quantitative easing is a sort of “non-traditional” way of stimulating the economy. It involves pumping quantities of money into the economy. The Fed is doing it by spending money to purchase mortgage backed securities and bonds. This essentially increases the money supply, making money cheaper to get, and encouraging consumer behaviors that supposedly boost the economy and result in hiring as businesses try to keep up with demand.
What are the Results of Quantitative Easing?
What does this mean for you, though? In practical terms, it means that money remains cheap. Mortgage rates, debt rates, and other costs related to money are likely to stay down. This means you have a chance to pay off your debt quickly, take advantage of it. You have a chance to pay off your debt in the next three years, and do so at relatively low rates.
Another possibility is that inflation could be an issue. When you have an increase in the quantity of money in the system, it becomes less valuable. Purchasing power is reduced, and it takes more money to accomplish the same thing. While we’re told that inflation isn’t a big deal right now, it could really kick into high gear later as a result of QE3. If that happens, then you can expect to pay more.
In terms of your investments, it’s worth it to note that markets tend to like quantitative easing. Bernanke’s announcement was greeted by huge jump in the Dow. Gold prices surged as well, as did oil prices. While the gains may not last, markets tend to respond enthusiastically — at least initially — to quantitative easing. Long term, though, the economic effects may not be as positive. The idea that we have to keep promoting growth for the sake of growth, and basing it all on trying to encourage consumers to borrow, is one that seems to have led to greater instability in the economy overall.
All this quantitative easing might lead to greater instability, as well as bigger crashes, closer together. What do you think? Is more easing the answer? Or do we need to try something else?