What is QE2 or Quantitative Easing 2?

What is QE2 or Quantitative Easing 2?
Quantitative Easing 2, or QE2 as it is referred to by some, was the effort by the United States Federal Reserve to increase the support for domestic economic activity in the US economy. The Federal Reserve started this effort in August of 2010 by taking the payments that it received on agency debt and agency owned mortgage-backed securities obtained during Quantitative Easing 1 and applying those payments toward investment in longer term Treasury securities. This helped to remove Treasury securities from private hands and put more cash into the economy.

The Federal Reserve bought more than $600 billion in long-term Treasury Bonds and reinvested almost another $300 billion from mortgage-backed securities into other Treasury securities. In total, well over $900 billion was spent in the Federal Reserve’s QE2 efforts. The theory behind this effort was that the yields would be driven down on Treasury securities and bonds while people would begin to spend more on consumption and investment activities in the domestic economy of the United States. Through the increased domestic economic activity, the Federal Reserve hoped to reverse the crushing recession that had started in late 2008.

One major drawback to QE2 was that the Federal Reserve ran a huge risk of causing severe inflation in the economy. In essence, by pushing more money into the economy through the efforts of Quantitative Easing 2, the Federal Reserve devalued the dollars that were already in circulation and ran the risk of causing prices of certain goods and services to rise faster than they would have if QE2 had not happened.

This risk of higher inflation has been seen throughout history any time a central bank has used quantitative easing measures to stimulate an economy. One of the most famous cases of severe inflation caused by quantitative easing was the hyperinflation that Germany experienced during the 1930s under the Wiemar Republic. Because Germany’s central bank did not effectively manage the inflation caused by its quantitative easing efforts, Germany experienced inflation that reached a rate of well over 1000%.

While some have said that because of this past example and the present high risk for inflation the Federal Reserve should not have implemented quantitative easing like it did during QE2, the policy has shown some overall effectiveness. The International Monetary Fund has said that because of quantitative easing, the Federal Reserve and other central banks around the world who followed similar policies greatly reduced the systemic risks in the developed economies of the world. The International Monetary Fund has said specifically that because the Federal Reserve implemented QE2 market confidence returned to the US economy sometime in late 2010. Several high ranking economists and Federal Reserve officials have concurred with the International Monetary Fund’s assessment and have specifically linked Quantitative Easing 2 to the rise that were seen in US stocks during late 2010 and throughout 2011. Federal Reserve Governor Jeremy Stein specifically has credited QE2 with “a significant role in supporting economic activity.”

The impact on the economy by Quantitative Easing 2 has been positive in some respects, especially since the US saw its exchange rates drop in comparison to other countries. This drop in exchange rates has led to a significant growth in the export of goods and services from the United States to other countries. However, it has harmed importers by causing prices to increase due to the devaluation of the US Dollar that was caused by QE2. In short, the domestic and export economies seem to have benefited from QE2 while there has been a net decline in imports into the United States. Overall though, QE2 appears to have been a good move by the US Federal Reserve.

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