Fed Challenge 2011 September Charlotte Office

Why QE2? “…reduced cost of credit to consumers and businesses, a rise in asset prices that boosts household wealth and spending, and a moderate change in the foreign exchange value of the dollar that provides support to net exports.” -Janet Yellen Also: Avoid deflation, increase confidence. We hit the zero lower bound. What is QE? QE2?

Conditions before QE2 Long-term unemployment may be affecting the NAIRU

Conditions before QE2

About deflation Deflation can encourage consumers to horde their money rather than spend it, as it will appreciate in value. It can necessitate counterintuitive nominal interest rates. With 2% deflation, a 1% real interest rate would be -1% in nominal terms, requiring the lender to actually pay the borrower to borrow. Unexpected deflation hurts borrowers, and could put them into excess debt. Deflation is commonly associated with recession, and can induce a deflationary spiral.

Proposed effect

Risks of QE2 Might be seen as monetizing the debt Creation of a new asset bubble Inflation down the road

Balance sheet Money supply did not explode

Implementation Purchased $600 billion in Treasuries over a 9 month period, targeted mostly towards the medium duration “Over the course of the program, our purchases ran at about the same pace as the total net Treasury supply coming to the market. Moreover, with the completion of the program, the SOMA portfolio holds about 18 percent of the outstanding stock of Treasury securities. Our share of the market is even higher at intermediate maturities, where our purchases were concentrated.”-Brian Sack

Effects “In particular, model simulations indicate that the past and projected expansion of the Federal Reserve's securities holdings since late 2008 will lower the unemployment rate, relative to what it would have been absent the purchases, by 1½ percentage points by In addition, we find that the asset purchases have probably prevented the U.S. economy from falling into deflation.” –Chung, Laforte, Reifschneider, Williams. Board of Governors and San Francisco Fed

Inflation today and QE3 tomorrow Also: Nick’s comments on the recent downturn in economic conditions

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