A primer on quantitative easing and what the Fed is trying to do:
http://www.ft.com/cms/s/0/8ada2ad4-f3b9-11dd-9c4b-0000779fd2ac.html
It’s a video, so here are the highlights if you can’t or don’t want to watch it:
-normally central banks set interest rates to regulate monetary policy
-interest rates cannot be below zero (it makes no sense for banks and would force people to stuff money in mattresses)
-so the Fed creates new money, increasing its own credit which is backed by the government
-it buys every asset in sight, increasing the price and yield of bonds and other assets
-this should encourage greater demand (and reduce bad assets), giving banks an incentive to lend and picking the economy out of recession
now the risks:
-the Fed could lose money on its purchases, and remember that the taxpayer is on the hook for the government’s losses
-this increases consumer prices, which could spiral into unstoppable inflation and destroy the value of the dollar
-this strategy depends entirely on market confidence, it can be counterproductive if people don’t think things are better
-must be done extremely aggressively or it won’t work, this is why it’s very risky and the central bank only does it as a last resort
-because it’s a last resort, it is necessarily rare, which means we have no empirical evidence how much is enough
I read a very interesting solution this morning to create de facto negative interest rates and spur spending. The Treasury could randomly pick a number 0-9 and say that every bill ending with that number will be worthless. That would create a massive game of hot potato as people tried to shed themselves of the dreaded bills, speeding transactions in the country. I don’t think it will happen, but it’s a fascinating idea.