Posts Tagged quantitative easing explained

Quantitative Easing and Inflation

Recently the Fed announced it would buy $600 Billion of Treasury securities and called the measure “quantitative easing”.  There are plenty of articles out there that can explain this but here it is in a nutshell…………The federal government is printing new money and using it to buy Treasury debt.  That’s right; our gov’t is printing money to buy securities from itself.  Sounds great — just print more money and we’ll never have a problem again!

Here’s the problem — printing new money ultimately will cause inflation which is most harmful to the poor and those on a fixed income.  Inflation has been held at bay for several key reasons including 1) an enormous amount of cash is sitting on the sidelines waiting for positive economic signs and 2) since people are not spending money, the “multiplier effect” is currently very low.  The multiplier effect occurs when the baker sells a pie and uses the money to buy shoes which allows the cobbler to buy a shirt from the tailor and so on.   When the baker isn’t selling as many pies, the rest of the system slows down too.

When economic activity picks back up it will do so in a relatively short period of time.  People will reinvest their money and the unemployment rate will decline significantly causing the multiplier effect to improve………and the newly printed dollars will still be out there.  The combined effect will result in inflation and some say extreme inflation.  Those who would argue that the Fed can just as easily sell Treasuries as it can buy them (and in the process slow inflation) are missing the point that the Fed and the White House are not opposed to the idea of inflation.

Devaluing the currency (allowing inflation) is, in effect, a method paying down national debt.  If inflation increases by 10%, we will have essentially repaid 10% of our debt.   This is a slight oversimplification but it is a long-standing strategy used by governments with overwhelming debt burdens………just print more money to pay the debt and kick the can down the street by signing the country up for future inflation.

Again, those hurt most by inflation are the poor and elderly who are on a fixed income.  A family that has $2,000 in monthly expenses will now have to pay an extra $200/month for those same expenses.  $200 is a lot for a low income family and can be the difference between eating two vs. three meals a day or deciding they can’t take their sick child to the doctor.

The answer is NOT more government programs or higher taxes.  The answer is for us all as a nation to collectively decide to live below our means.  Unfortunately, since we are already in difficult economic times that will hurt a lot more for some.  For the family that decides to drive an 8 year old car for another three years vs. getting a new car, there might not be too much pain.  For the family that has to decide whether or not to take their child to the doctor, the pain is much higher.

“Austerity” will be a word commonly used over the next few years and for good reason.  There really is a limit to the benefits governments can provide as we’ve seen from Greece and now from Ireland & Portugal.  It is not a political issue but a math formula………too many people draining too much too much from the system + not enough people contributing to the system = insolvency as a nation.

By printing another $600 Billion, the Fed has effectively kicked the can down the street but time marches on and there will be a price to pay eventually in the form of inflation.


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