“The sky will fall. Inflation will soar. Money will be worthless. Stocks will crash. Auto sales will plummet and Indiana’s economy will go into the tank again.”
That is the dire prediction of many who fear the Federal Reserve (the Fed) cutting back its Quantitative Easing (QE) policy.
If my experience is correct, very few Hoosiers know about QE other than as shorthand for Queen Elizabeth. This QE is how our federal central bank has been fighting to keep our financial institutions from failing, and to stimulate the economy. The process can be complicated, but the idea is simple. Remember when the stocks, bonds, mortgages and other financial assets owned by banks, insurance companies and others crashed in value in 2008? The Treasury Dept. and the Fed went in to relieve those institutions of their “toxic assets”.
After that was done, the Fed found the economy was not returning to health fast enough and decided on buying program under the name of Quantitative Easing. Thus the Fed went shopping for bonds, mortgages and other bargain assets, boosting their prices.
When the Fed makes such a purchase, it transfers money to the seller’s bank account. Either the money sits there or is spent on something.
If the money sits, the bank may lend it to a borrower who spends it on something. But what if the bank does not lend the money? Perhaps, the bank cannot find a risk-free borrower. Possibly, the bank is intimidated by new regulations intended to protect customers.
Similar points can be made about other financial institutions who sell assets to the Fed. An insurance company, for example, might take the money out of its bank account and pay it out as profits to its shareholders or bonuses to its executives.
Under QE, $84 billion a month is pumped into asset markets and prices rise, as we have seen on the stock market. Owners of stocks, who tend to be among the richest Americans, become wealthier and spend a little of it on baubles or boats. The balance they reinvest in a rising stock market to make more money.