David Lerner Associates: QE, QE2, QE3 -Deciphering the Code
You may have heard these terms used recently when it comes to the economy but have no idea what they mean. If so, don’t feel bad—outside of economists and professional investors, many Americans are fuzzy about their actual meaning and relevance.
QE stands for Quantitative Easing, which is a monetary policy tool used by the Federal Reserve to help spur economic growth. It involves the creation of money by the Fed, whereby the Fed purchases longer-dated U.S. Treasury bonds and other financial assets (like agency mortgage-backed securities) from banks.
“The goal is to put more money into the hands of banks, which they can then lend to consumers and businesses to hopefully spur more business growth, expansion, hiring and overall economic activity,” says David Lerner Associates Senior Vice President of Trading, Douglas Revello. “In addition, QE helps drive bond prices up, since their supply is reduced, and their yields down. These lower yields may help spur more economic activity by lowering borrowing costs.”
Quantitative Easing is one of several monetary policy tools at the Fed’s disposal to try to help jump-start the economy. The first is interest rates, which the Fed controls by raising or lowering the Federal Funds rate, which is the interest rate at which banks lend reserves to other banks.
In September 2012, the Federal Reserve Open Market Committee (FOMC) announced that it planned to keep the target Federal Funds rate low (between 0 and.25 percent) through mid-2015. With interest rates effectively cut to zero, this policy option is no longer on the table, leaving the Fed with QE and a third policy referred to as Operation Twist. “Here, the Fed purchases long-term bonds and sells short-term bonds in an effort to bring down long-term interest rates and stimulate economic growth,” Revello explains.
The first round of QE was begun in November of 2008, and it was followed by QE2, which ran between November 2010 and June 2011 and involved the purchase of another $600 billion in short-term bonds by the Fed. With economic growth still slow, the Federal Reserve announced another round of Quantitative Easing, or QE3, on September 13, 2012.
In this round, the Fed will buy $40 billion in agency mortgage-backed securities per month. In its statement accompanying the announcement, the Fed indicated that this round of QE would be open-ended—or in other words, the Fed may increase its bond-buying if the economy and employment do not improve:
“If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”
It’s important to remember that monetary policy tools like Operation Twist and Quantitative Easing are just that—tools that the Federal Reserve can use to try to stimulate economic growth. “But there is no guarantee that they will achieve their stated desire,” says Revello. “For example, just because banks have extra capital doesn’t mean that they have to lend it to consumers and businesses. If they don’t, these tools may not achieve the economic growth goals that are intended.”
Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates,Inc. (DLA). This material does not constitute an offer or recommendation to buy or sell securities and should not be considering in connection with the purchase or sale of securities. Member FINRA & SIPC.
Founded in 1976, David Lerner Associates is a privately-held broker/dealer with headquarters in Syosset, New York and branch offices in Westport, CT; Boca Raton, FL; Teaneck and Princeton, NJ; and White Plains, NY. For more information contact David Lerner Associates 1 877 367 5960 http://www.davidlerner.com