By: Dr. Mike Campbell
The Federal Reserve announced last week that it would inject $600 billion into the US economy by June 2011. The idea is that the money will be used to buy long-date government debt through US banks. The purchase of such large quantities of government bonds would increase their desirability and push down their yields (somewhat paradoxically). This in turn, means that the US government will need to pay less money to service its borrowing since the yields on the bonds will have fallen.
The banks get commission on the transactions which, according to the theory, they can then lend to business, increasing liquidity in the economy and stimulating growth. However, since the move forces yields down, it is likely to make the Dollar weaker against other major currencies. This will give US exporters a competitive advantage over their opposite numbers in other leading economies and it will also push up the costs of imports into the USA.
The Germans, Chinese, South Africans and Brazilians have all being quick to criticise the American move. The German finance minister, Wolfgang Schraeuble, described the move as “clueless” and has said that Germany will seek bilateral talks with the US at the forthcoming G20 leaders meeting. The Brazilians and the South Africans both stated that they believe that the move would harm exporters from the developing world seeking to sell goods in the American market.
Unsurprisingly, Federal Reserve chairman, Ben Bernanke, has defended the move. He pointed out that it is the role of the Fed to ensure low and stable prices in the US and to take measures to support employment. He denied that QE would lead to asset bubble formation or higher inflation, pointing out that the economy had been suffering from deflationary pressure since the onset of the global financial crisis.