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Kimberly Amadeo

Fed's QE4 Buys Time for Fiscal Cliff Resolution

By December 13, 2012

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In an unprecedented move, the Federal Reserve announced that its Quantitative Easing program will remain in place until either unemployment is under 6.5% or inflation rises above 2.5%. By being so specific in its target, the Fed almost guarantees that QE4 will continue through 2013. That's because unemployment is now at 7.7% and inflation is just hovering below 2%. This gives Congress and the President time to negotiate a solution to the fiscal cliff.

What exactly is QE4? The Fed will continue buying $85 billion in long-term notes and mortgage-backed securities from banks. However, it will discontinue Operation Twist, where it sold short-term Treasury bills when they became due, and bought long-term 10-year Treasury notes. Instead, it will roll over the short-term bills. The Fed previously announced it will keep the Fed funds rate at zero until 2015. (Source: Forbes, QE4 Is Here, December 12, 2012)

How does QE4 help the economy? By buying Treasuries and MBS, the Fed is basically printing money. This additional $85 billion a month of liquidity stimulates growth. (To understand how this works, see Expansionary Monetary Policy.) It also will offset the contractionary fiscal policy (tax increases and spending cuts) that resolving the fiscal cliff requires.

What It Means to You

First, the Fed's actions ensure that interest rates will remain low for the next year. This will help housing, which could take a hit if Congress removes a part of the mortgage tax deduction.  It will also boost business growth by pushing investors into any higher-yielding investment, including corporate bonds and stocks. Low rates are also spurring demand by encouraging shoppers to save less and borrow more. (See Shoppers Resume Love Affair With Credit Cards.)

Will QE4 lead to inflation? No. The Fed can easily sell Treasuries if inflation rises above 2.5%. However, it will eventually be more difficult if Congress doesn't resolve the fiscal cliff and cut the deficit.

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