Wednesday, June 29, 2011

QE-II to expire without a successor

The relationship between economic growth and inflation may be analogised to that between bacteria and acid in a culture. Inflation is a by-product of  economic growth, excessive inflation kills economy (just like acid in a bacteria culture)

Monetary & fiscal policies are aimed at maintaining a healthy balance between 'economic growth' and 'inflation'. In order to stimulate economic growth in USA, Fed tried all monetary and fiscal tools like cutting down interest rates and inducting govt. spending into infrastructure and renewable etc to pump up investment and employment. But these traditional measures failed to resuscitate US economy back to life.

After having hit ground zero on interest rates and getting caught into zero bound doldrums, the Fed embarked upon QE to further stimulate the economy. Quantitative easing is about injecting liquidity into the system. Central bank dons Santa clause's red suit and goes shopping assets which a rational market won't buy. e.g. Central bank buys bonds from commercial banks at higher than market price so that they may further invest the money.
Over the course of QE 1, which spanned from November 25th, 2008 to about March of 2010, the Fed purchased about $1.75 trillion of assets. This is equivalent to easing of from 50 to 125 basis points on interest rates. Not getting the desired results a second round of $600 billion in additional stimulus, known as QE 2, was kicked in, which is coming to an end on the 30th June this year. This has translated into an additional 18 to 56 basis points of easing.

But these extra-ordinary efforts have not yielded the desired results. These efforts have failed either to boost economy growth rate appreciably or address employment problem in US. On the other hand the extra money pumped in has resulted in very high levels of inflation world-wide specially in growing economies. Governments in these countries will have a tough time combating the menace before people stuff ballot boxes with hate mail to vote them out of power.

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