Quantitative easing is a horrible term in service of a necessary goal. It is economic
stimulus. It's not like the famous stimulus passed in Obama's first
month, which cut taxes and raised spending by more than $800 billion.
Instead, the Federal Reserve lowers interest rates and buy debt from investors to encourage them to
lend more money.
My favorite way to understand the purpose of quantitative easing comes from an extended metaphor from Chris Hayes.
Imagine the economy as an irrigated farm with the Fed as the farmer in
charge of the spigot and the water and the pipes. When things are
growing, the Fed must be careful to not drown us with too
much money. But when the things are dry, as they are now, it's the Fed's
responsibility to return the farm to growth.
For the last four
years, the Fed has tried almost everything to irrigate the economy. By
lowering interest rates, it kept money flowing between the banks. By
buying debt from investors, it scraped the gunk off the pipes,
increasing liquidity and encouraging more lending, more spending, more
hiring. But unemployment is still over 8% and growth is still slow. Why?
explanation is that the Fed has failed from lack of creativity and
will. Most of the economists I read think the central bank should
announce a higher inflation target to super-charge spending and
investment. They might be right. But the other thing to remember is
that, like any farmer, the Fed doesn't control all the variables for
growth. High household debt, a weak global economy, and awful
residential investment are all contributing to our economic drought.
The Federal Reserve doesn't have explicit answers for these problems. Unlike Congress, it cannot send checks to families in the mail to raise income, or increase spending for defense contractors to raise employment. Instead, its policies can change expectations to encourage families and businesses to invest with confidence. By raising inflation expectations, QE can give the stock market a boost, and by lowering long-term interest rates it can encourage families to buy houses.
You might say that a frothy stock market isn't exactly the most efficient way to help a lower-income family that's never thought about stocks in their life. But, as I've written, a rising stock market isn't just good news for large companies and
investors. It can also help overall consumer spending.
In an impassioned
defense of QE2, economist Martin Feldstein noted that the economy's
strong rally at the end of 2010 was driven by a sharp increase in real
personal spending, which in turn was driven by a decline in the savings
rate and a sharp increase in the stock market. "There is no proof that
QE2 led to the stock-market rise, or that the stock-market rise caused
the increase in consumer spending," Feldstein admitted, "but the timing
of the stock-market rise, and the lack of any other reason for a sharp
rise in consumer spending, makes that chain of events look very