Fed Hints at Potential of QE2

The Fed, in it’s FOMC meeting notes (September 2010), announced that it might be using quantitative easing again this year, with the market calling it QE2. In it’s September meeting, it echoed sentiments from its August meeting about the slowing economy and stated that the Committee is prepared to provide “additional accommodation” if necessary – codeword for quantitative easing.

Why is this notable? If the economy were really recovering as nicely as many of us would like to believe, then quantitative easing wouldn’t be necessary. If we’re back on track and we aren’t facing deflation, QE1 worked, and we should just continue on with business as usual. By mentioning the potential for another round of quantitative easing, the FOMC introduces the idea that maybe we’re not recovering as nicely.
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What is Quantitative Easing?

Quantitative easing, known as QE, is a monetary policy used by a central bank to increase the money supply by increasing the excess reserves. In layman’s terms, they inject a lot of new money into the money supply through open market operations. If this sounds like the central bank is just printing more money, you’re right (technically they just make up money out of thin air electronically, no actual printing is necessary). The specifics of how they do this are probably not important to 99.99% of us, but they’re explained below, but what is important is why a central bank like the Federal Reserve would want to do this.

How is QE accomplished?

(in case you were curious) The central bank essentially credits its own account with new money and uses that money to buy assets from banks, thus increasing the reserves at those banks. Those banks can then lend that money out at a multiple based on the reserve ratio. If the ratio is 10%, then they can lend out 90% of the amount of the added reserves. Reserve ratios are the percentage of an asset they must keep as reserves (so if you have $100 and the ratio is 10%, you can lend out $90). The next bank can lend out $81, keeping $9, and so on and so forth.

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