How will the end of the $600 billion economic stimulus package affect your business?
The end of June 2011 marks the conclusion of the $600 billion economic stimulus program known as “Quantitative Easing 2” or “QE2.” It’s called “2” because it represents the second round of quantitative easing undertaken by the Federal Reserve after the financial crisis spurred by the collapse of Lehman Brothers.
Before discussing what the implications are for your business, it’s important to understand what is meant by QE2. The impact on the economy will be significant.
What is quantitative easing?
Quantitative easing is a way for the central bank of a country to stimulate an economy when other traditional methods have failed. To implement quantitative easing the central bank purchases government bonds and other financial instruments mainly from banks. They pay for these in cash and do it on a massive scale.
The banks then have a surplus of highly liquid reserves at their disposal that gives them both the ability to lend more and creates pressure to lend more as a way to achieve returns on this money. The goal is to stimulate the economy by increasing the amount of capital and credit available.
So where does a central bank come up with the cash to fund quantitative easing? That’s the fun part. They just create it from thin air. They are, after all, the central bank and they can do this. A few strokes on the keyboard and suddenly hundreds of billions of dollars are created electronically and are now available for use.
Why was quantitative easing used?
The Federal Reserve—which is the central bank of the United States—has a number of tools at its disposal to stimulate the economy. The most widely-used tool is the target federal funds rate. This is the interest rate that banks charge when they lend money to one another for short periods of time. The Federal Reserve sets a target for this rate and then makes sure it stays on target. As of this writing, the rate was between 0 percent and 0.25 percent. This hasn’t changed since December 16, 2008.
The impact of this percolates throughout all interest rates in the economy, including business loans, mortgages, car loans and more. The belief is that low interest rates will stimulate borrowers to take advantage of access to cheap capital for investment and spending purposes. This should in turn stimulate the overall economy. Nothing, however, is quite that simple.
For two and a half years we have had the lowest of the low target federal funds rate yet the economy is still going through agonizing attempts at recovery. When financial institutions are overly cautious with their lending, consumers are worried about job security and businesses have little clarity into the near future, even nearly free money like we have available now isn’t enough to stimulate the economy.
So what does a central bank do when it can’t give money away? It creates money out of thin air and calls this quantitative easing.
