Not for love of money, but of Humanity. "Greater is he who works for the good of all, then he who works for the good of himself only" ~ Matthew 25:40: "The King will reply, 'I tell you the truth, whatever you did for one of the least of these brothers of mine, you did for me.'"- (NIV). I live in Singapore where the Emperor must not be disturbed.

Saturday, December 4, 2010

Printing money to push spending

Printing money to push spending
These pages will carry occasional briefs on particular subjects, written by experts in the field. Today, Professor Linda Lim writes about quantitative easing and its effect on various economies.

  • What is the Fed and what does it do?
    The Federal Reserve is the central bank of the United States. Like other central banks, it is responsible for the money supply (issuing US dollars), monetary policy (setting interest rates, bank credit requirements, and the purchase and sale of government bonds, known as 'open market operations'), and financial system supervision.
    The Fed is required by law to ensure an 'appropriate balance' between inflation and unemployment in the US economy. It is independent of the US government, to ensure that its policies are not unduly influenced by electoral politics.
    Fed governors are nominated by the President and confirmed by the Senate for staggered 14-year terms. They are typically economists, former bankers or financial regulators.

  • Why are some Americans, including 'Tea Party' activists, opposed to the Fed?
    They are suspicious of the Fed's independence from elected representatives, making it 'a law unto itself', out of the control of politicians - which is actually by design. They are suspicious that the Fed is unduly influenced by banks and other financial institutions, thus biased towards 'Wall Street' at the expense of 'Main Street'.
    They blame the Fed's past monetary stimulus for causing the recent financial crisis, and accuse it of 'bailing out' undeserving banks that caused the crisis.

  • What is QE2 and why is the Fed undertaking it?
    QE2 refers to a second package of 'quantitative easing' that the Fed recently announced. The first monetary stimulus in 2008 at the onset of the financial crisis saw the Fed aggressively lower interest rates and inject US$1.75 trillion (S$2.26 trillion) into the US economy.
    QE2 involves the phased purchase of an additional US$600 billion of Treasury bonds, with newly printed US dollars. The Fed is doing this to boost purchasing power in the economy, hoping to stimulate consumer demand and business investment, thus creating jobs.
    Monetary and fiscal stimulus policies enacted in 2008 and last year succeeded by June last year in ending the severe recession following the financial crisis. But unemployment remains high, at just under 10 per cent of the labour force, while inflation of 1 per cent is lower than desired.
    Further fiscal stimulus is unlikely if not impossible, because the national debt, aggravated by the 2008-09 fiscal stimulus, has swelled to politically unacceptable levels.
    This leaves further monetary stimulus as the only means left to reduce unemployment. Since interest rates are already close to zero, 'printing money' to buy back government bonds is the one remaining policy tool. (There is little actual printing of money, of course, but the Fed does create money ex nihilo, out of nothing, in order to buy Treasuries from the market.)
    The Fed believes that putting money into people's pockets and corporate coffers will induce them to spend, undermining deflationary pressures and raising asset prices so a 'positive wealth effect' will induce more spending, creating employment.

  • So why are many Americans opposed to QE2?
    Some believe that since monetary and fiscal stimulus has been ineffective so far in reducing unemployment, more monetary stimulus will be similarly ineffective. Others are concerned that printing money will increase inflation by more than the Fed expects. Some Americans are ideologically opposed to the Fed further expanding its balance sheet, which is seen as both financially risky and symptomatic of 'big government'.
    There are also concerns that 'cheap money' will induce risky financial behaviour such as that which led to the financial crisis in the first place.
    The Fed argues that it can always reverse its bond-buying if inflation picks up, while post-crisis regulatory reform has reduced financial market risks. Previous stimulus was successful in halting the recession, with the government reducing its role as the private sector recovered.
    The writer, a Singaporean, is professor of strategy at the Ross School of Business, University of Michigan.

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