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      Blog :: 10-2014

      A Riddle Wrapped In a Mystery in an Enigma

      Quantitative Easing: Does It Work? Text by Lisa Smith for Investopedia

      If there were awards for the most controversial investment terms, "quantitative easing" (QE) would win top prize. Experts disagree on nearly everything about the term - its meaning, its history of implementation, and its effectiveness as amonetary policy tool.

      The U.S. Federal Reserve and the Bank of England have used QE to weather financial crises. In fact, the U.S. has had three iterations: QE, QE2, and QE3. TheEuropean Central Bank (ECB), meanwhile, is prohibited by E.U. law from using QE. But that may have to change, some signs indicate. On April 3, 2014, at a press conference in Frankfurt, ECB chair Mario Draghi made the controversial, but not unexpected announcement that the bank could not rule out QE as a method for fighting the malaise of persistent deflation in the eurozone. Desperate times, desperate measures. So what's the big deal about QE - and does it work?

      The Basics Popular media's definition of quantitative easing focuses on the concept of central banks increasing the size of their balance sheets to increase the amount of credit available to borrowers. To make that happen, a central bank issues new money (essentially creating it from nothing) and uses it to purchase assets from other banks. Ideally, the cash the banks receive for the assets can then be loaned to borrowers. The idea is that by making it easier to obtain loans, interest rates will drop and consumers and businesses will borrow and spend. Theoretically, the increased spending results in increased consumption, which increases the demand for goods and services, fosters job creation and, ultimately, creates economic vitality. While this chain of events appears to be a straightforward process, remember that this is a simple explanation of a complex topic. (For a closer look at how they print money and seek to control inflation, check out The Fed's New Tools For Manipulating The Economy.) Quantitative Easing, Throwing Money at the Wind

      In the United States, the Federal Reserve serves as the nation's central bank. To learn about the tools the Federal Reserve uses to influence interest rates and general economic conditions, see Formulating Monetary Policy andUnderstanding The Federal Reserve Balance Sheet.

      The Challenges Closer analysis of QE reveals just how complex the term is. Ben Bernanke, renowned monetary policy expert and chairman of the Federal Reserve, draws a sharp distinction between quantitative easing and credit easing: "Credit easing resembles quantitative easing in one respect: It involves expansion of the central bank's balance sheet. However, in a pure QE regime, the focus of policy is the quantity of bank reserves, which are liabilities of the central bank; the composition of loans and securities on the asset side of the central bank's balance sheet is incidental." Bernanke also points out that credit easing focuses on "the mix of loans and securities" held by a central bank.

      Despite the semantics, even Bernanke admits that the difference in the two approaches "does not reflect any doctrinal disagreement." Economists and the media have largely disregarded the distinction by dubbing any effort by a central bank to purchase assets and inflate its balance sheet as quantitative easing. This leads to more disagreements. (For more read The Federal Reserve's Fight Against Recession.)

      Does Quantitative Easing Work? Whether quantitative easing works is a subject of considerable debate. There are several notable historically examples of central banks increasing the money supply. This process is often referred to as "printing money", even though it's done by electronically crediting bank accounts and it doesn't involve printing.

      While spurring inflation to avoid deflation is one of the goals of quantitative easing, too much inflation can be an unintended consequence. Germany (in the 1920s) and Zimbabwe (in the 2000s) engaged in what many scholars refer to as quantitative easing. In both cases, the result was hyperinflation. However, many modern scholars aren't convinced that the efforts of these countries qualify as quantitative easing.

      In 2001-2006, the Bank of Japan increased its reserves from 5 trillion yen to 25 trillion yen. Most experts view the effort as a failure. But again, there is debate over whether or not Japan's effort can be categorized as quantitative easing at all.

      Economic efforts in the United States and the United Kingdom during 2009-10 also met with disagreement over definitions and effectiveness. European Union countries are not permitted to engage in quantitative easing on a country-by-country basis, as each country shares a common currency and must defer to the central bank.

      Stalled CarThere is also an argument that QE has psychological value. Experts can generally agree that quantitative easing is a last resort for desperate policy makers. When interest rates are near zero but the economy remains stalled, the public expects the government to take action. Quantitative easing, even if it doesn't work, shows action and concern on the part of policy makers. Even if they cannot fix the situation, they can at least demonstrate activity, which can provide a psychological boost to investors. Of course, by purchasing assets, the central bank is spending the money it has created, and this introduces risk. For example, the purchase of mortgage-backed securities runs the risk of default. It also raises questions about what will happen when the central bank sells the assets, which will take cash out of circulation and tighten the money supply. (For more on this, check out When The Federal Reserve Intervenes (And Why).)

       

      When Was Quantitative Easing Invented?

      Even the invention of quantitative easing is shrouded in controversy. Some give credit to economist John Maynard Keynes for developing the concept; some cite the Bank of Japan for implementing it; others cite economist Richard Werner, who coined the term.

      The Bottom Line The controversy surrounding QE bring to mind Winston Churchill's famous quip about "a riddle wrapped in a mystery inside an enigma". Of course, some expert will almost certainly disagree with this characterization.

      Connect to maplesweet.com, e-mail info@maplesweet.com or call toll-free 1-800-525-7965 to find out more about market influence and updates, to list or buy property in Vermont, or with any inquiries.

      See the Maple Sweet Real Estate listings Portfolio and the newest Vermont mls listings.

       

      Rob Tierney of MSA Mortgage on Quantitative Easing, the Fed, Bonds and Low Interest Rates

      By Rob Tierney of MSA Mortgage   rob@robtloans.com

       

      After the financial meltdown in 2008 the Federal Reserve began using various monetary tools to re-ignite the economy after the worst financial decline since the Great Depression. One of these tools was QE (quantitative easing). Their stated goal was to keep interest rates low and to target inflation to 2%

      For several years the Fed used QE1, QE2 and in 2013 they used an additional variation of QE to continue the low rate environment while inflation was low and the economy continued to chug along at an anemic pace.  At Press

      In May of 2014 the Fed announced they would reduce QE bond purchases by 10 billion per month and discontinue QE by the end of October 2014. Up until that point 30 year fixed rates were in the low 3%'s. Once the Fed announced in May of 2014 that QE would end in October 2014 rates increased over 1% to the 4.250% - 4.500% range. Conventional wisdom said that 30 year fixed rates would continue to rise slowly throughout 2014 into 2015 when the Fed would begin raising rates again.

      Due to recent global economic volatility, and lower than expected inflation, we have seen conventional wisdom turned on its head.

      Hour-GlassWith the European economy slipping close to recession the outlook for this year is very different. We have seen a decline, rather than an increase, in long term interest rates.

      Long rates are most closely associated to the 10 year Bond yield. Throughout late 2013 and into 2014 we saw the 10 year Bond yield drop to historical lows. Conventional wisdom had the yield up to almost 3.000% by the end of 2014. Since the recent global volatility the 10 year yield dropped yesterday to its lowest point since the spring of 2013. Today the 10 year Bond yield is 2.370%

      This phenomenon may not last so this is a great opportunity to secure a low fixed rate. If you missed the boat on refinancing or are looking to purchase a home the time is NOW. Interest rates are tied to the news cycle and it can change quickly.

      Connect to maplesweet.com, e-mail info@maplesweet.com or call toll-free 1-800-525-7965 to find out more about current  interest rates, mortgage providers including MSA Mortgage, how you can qualify for home financing, how to submit a mortgage application or with any other financing related inquiries.

      See the Maple Sweet Real Estate listings Portfolio and the newest Vermont mls listings.