QE3: Risking Inflation or Creating Growth?

by Blair Urish 25. September 2012 08:34
  The Federal Reserve announced that they would start a third round of quantitative easing (QE3) recently.  The Federal Reserve has had two previous rounds of quantitative easing in an effort to manage their duel mandate to: 1. Maintain price stability (low inflation) and 2. Maintain low unemployment. The Fed explained that they would buy mortgage-backed securities (MBS) at a pace of $40 billion per month (on top of the $45 billion per month currently being spent for “Operation Twist”) in an effort to jumpstart the stalled unemployment rate and improve economic growth.  To accomplish this, the Fed is trying to maintain low interest rates and inflation while at the same time pump money into the economy by purchasing bonds.  The increase in the demand for bonds pushes yields down so that there are more attractive interest rate and loan opportunities for potential borrowers and lenders thus stimulating demand for money and new projects and businesses. What is the issue?  The exit strategy (selling of the debt securities) for Mr. Bernake’s QE3 is both precarious and unclear.  The Fed will ultimately have to sell the bonds or let them mature, leaving the government and the MBS market without a perpetual buyer of their paper. The risk of selling a trillion dollars of Treasury bonds on the market is that it will possibly drive up interest rates, which will erode purchasing power by potentially leading to inflation. Keep in mind that “every 1% increase in federal borrowing costs adds $100 billion to the annual budget deficit.”  This will put additional pressures on companies, state, and local government’s ability to refinance bonds that come due. Sooner or later the economy will improve, banks will begin to lend and the money supply will expand. Inflationary pressures will build rapidly if the Fed does not respond by reducing its balance sheet. Once inflationary signs pickup, I hope that Mr. Bernake, or the current fed chairman after the upcoming election, will come through, keep inflation expectations anchored and not squander the great credibility that has been built up over the past 30 years.  Based on comments in the article researched for this blog listed in the link above, it looks likely that once you let Pandora out of the box, it is very hard to put it back in, particularly in such a divisive and charged political climate.  Investors and businesses may be wary of inflation and take precautionary measures in their investments.  See Urish Popeck's Wealth Management Group for additional information.  
Categories: Advisory