8/13/2019 QE3 in the US

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Quantitative Easing comes into play when interest rates hit the zero-lower bound and

conventional monetary policies are no longer effective in inducing consumption and

investment through decreasing interest rates.

QE injects liquidity into the market through the purchase of of securities from the

market and thus increasing the Money Supply. We flood financial institutions withcapital in an effort to promote increased lending and liquidity. But the major risk is that

although more moey is floating around there is still a fixed amount of goods for sale.

This will eventually lead to higher prices or inflation

The ongoing weakness of the American economy, where deleveraging in the private and

public sectors continue apace, has led to stubbornly high unemployment and sup-par

growth. Furthermore, the effects of fiscal austerity- a sharp rise in taxes and sharp fall in

government spending are undermining economic performance even more

Recent data reveals slow growth, high unemployment and inflation well below the Fedstarget, which means this is no time to start constraining liquidity because this will

simply aggravate matters

Problem is that the liquidty is not creating creditfor the real economy, only boosting

leverage and further risk taking through the issuance of risky junk bonds under

loose covenants with excessively low interest rates. This is clearly shown by how

the stock market is reaching new highs, despite the growth slowdown, and money is

flowing to high-yielding emerging markets.

What Im concerned with, is that risky assets will reach bubble levels. QE3 is slated to

continue until the labour market has improved sufficiently, with the interest rate at 0%

Even if the Fed starts to raise interest rates, it will proceed slowly. In the previous

tightening cycle, it took the Fed 2 years to normalize policy rate. Rapid normalization

would no doubt crash the markets and risk leading to a hard economic landing

Financial markets are already frothy now, imagine how frothy it will be in 2015 when

the Fed starts tightening. The last time that interest rates were too low for too long it

led to excessive lending and huge bubbles in credit, housing and equity markets, and we

all know how that ended.

Problem is Fed has only ne effective instrument: Interest rates. And it can either go for

interest rate stability or economic stability, or in other words targeting the aggregate

output. If I keep rates low for long enough and normalize them slowly, then a huge

credit and asset bubble would emerge in due course. If I focus on financial stability then

I can increase the policy rate much faster