QE2, Extended Remix

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For the past six months, the Federal Reserve has been creating money out of thin air at a rate of billions of dollars a day. This will stop later this month, as planned.

In one sense, this will mark the end of the latest round of quantitative easing (QE2), in which the Fed created $600 billion and used the money to buy government bonds.

But ? and this is key ? the Fed is going to leave all that new money out in the world until further notice, by buying new bonds as its existing investments mature. In this sense, the effects of QE2 will continue until the Fed decides to stop buying new bonds.

By the same token, the first round of quantitative easing ? the Fed's purchase of more than $1 trillion of bonds with newly created money ? is still with us, because the Fed has continued buying new bonds to replace those that mature.

In other words, the drastic measures that the Fed has taken in the past few years to lower interest rates and goose the economy aren't winding down. They're still in full force, and will remain in place until further notice.

?

This is how the Fed looks at things. Ben Bernanke said as much at his press conference this spring:

...what matters primarily for interest rates, stock prices, and so on is not the pace of ongoing purchase, but rather the size of the portfolio that the Federal Reserve holds. ... we are going to continue to reinvest maturing securities ...monetary policy easing should essentially remain constant going forward from June.

Eventually, the Fed will decide that the economy has recovered enough to wind down its quantitative easing programs. As Bernanke said at the press conference:

...it's very likely that an early step would be to stop reinvesting all or part of the securities which are ... maturing. But take note that that step, although a relatively modest step, does constitute a policy tightening because it would be lowering the size of our balance sheet and, therefore, would be expected to essentially tighten financial conditions.

But the Fed is unlikely to take that step anytime soon, particularly if the grim economic news we've been hearing this week continues.

Indeed, the Fed may announce to that plans to keep reinvesting the proceeds for some time to come, Bloomberg News notes.

There's a clear precedent for this: For years now, the Fed has been saying that it plans to keep short-term rates extremely low "for an extended period."

Source: http://www.npr.org/blogs/money/2011/06/02/136884224/qe-2-extended-remix?ft=1&f=1017

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