QE3, Does It Offer A Total Cure?

The previously failed attempts to reduce unemployment and boost growth in the largest economy of the world have prompted the Central Bank of America (Federal Reserve) to go for another round of quantitative easing, popularly called as QE3. Under this arrangement, the Fed will purchase mortgage debt at the rate of USD 40 billion per month. With this its exposure to long-term security holding will expand, which will increase the growth rate in the U.S. as well as reduce unemployment in the country. 

The growth projections by Fed say that the QE3 will expand the GDP of the U.S. from the current 2.4 per cent to 3.8 per cent by 2015. The unemployment rate will decline from 8.2 per cent in 2012 to below 8 per cent in 2013 and 2014 and below 7 per cent by 2015. The projections however also show that the risk of inflation will rise to 2 per cent in 2015 from the current level of 1.8 per cent. The more optimistic projections show that by 2015, GDP growth will be 4.2 per cent, unemployment rate will be 6.9 per cent and inflation will be up by about 2.3 per cent. 

In an attempt to boost economic growth after the mortgage bubble and subsequent meltdown, Fed had announced QE1 and QE2 in 2009. QE1 is widely accepted as a successful effort but QE2 did not meet the expectations. In fact, growth in the last two years seemed halted. The debt crisis in Europe may have partially contributed to it but the overall result is that QE2 did not help to boost the growth curve in the American economy. 

Besides, now the U.S. is heading for presidential election in 2014 and the Republicans have been critical of President Barack Obama, saying that he has not achieved any success in lifting the employment rate and growth in the country. Republicans have also said the Fed has lost its credibility due to QE3. The Fed, in its attempt to keep the interest rates lower, has also said that it would most probably hold the rates near zero for at least up to mid-2015. The injection of liquidity (QE) will further increase the money supply and bring down the interest rates. This possibly will help push up the demand for home loans and create more jobs. 

Federal Reserve’s chairman Ben Bernanke’s policy has not indicated till when the QE3 will go on and neither has it provided any indicator about when he will tighten the screws around the economy. His statement “We are going to give it some time to make sure that the economy is well established” gives an indication that the U.S. economy is not showing significant growth and the near-term picture is also not very good. The U.S. economy grew by 1.7 per cent in the second quarter, which is far below the 4.1 per cent growth that it achieved in the final quarter of last year. 

The Fed’s chairman also said that the monetary policy cannot be a panacea for all ills and that the government must raise the taxes and initiate spending cuts in order to reduce the fiscal gap.

Immediately after QE3 was announced the U.S. markets displayed a hefty boost. The global indices have also jumped up as the money will now flow to other markets in search of better returns on investments. The QE3 will however lead to an increase in the commodity prices and thereby create room for inflation to grow. 

As per today’s WPI data, the inflation in August shot up to 7.55 per cent as against 6.87 per cent in July 2012. The WPI numbers clearly fade out the chances of a cut in the interest rates. The QE3 will further put inflationary pressure and hence domestic growth may remain subdued. As for the capital markets, this seems to be good news and we expect the markets to show gains for quite some time.