Rescuing the American monetary system.

On November 3rd, the FED’s chairman Ben Bernanke announced that the FED will undertake a second round of Quantitative Easing, in order to restore the American economic system. The principle is based on a series of consequences, starting with the FED buying long-term bonds with newly created money.

The consequences are the following:

1: long-term yields lower.
2: investors tend to riskier investments.
3: the dollar’s exchange rate drops, due to the lower yields.
4: share prices rise

In theory, these consequences should boost the economy in three ways:

1: since the long-term yields are lower, people are spurred to borrow and to invest.
2: increased share prices result in higher wealth for the households, which leads to more spending.
3: a cheaper dollar stimulates export.

The first result is a questionable one. Many households are not able to get a loan from a bank given the fact that the market value of their homes has fallen, and the banks are not too eager to lend them money. On the other hand, the third result was already reported by exporting companies. So even though the FED has to deal with a lot of criticism on its monetary policy, it does look like its working.

Sarah Duurloo

Down the slipway
The Economist
6^th November 2010