What is QE3: Quantitative Easing Explained in Simple Terms

Impact
By Chris Miles

What is quantitative easing, aka QE? 

And what is QE3? And whatever happened to QE2? Was there ever a QE1?

Well, that's an interesting question. And it's kind of hard to answer. But here's my best shot.

First, why are we talking about QE? On Thursday, the Federal Open Market Committee announced that the Federal Reserve will purchase $40 billion a month in mortgage-backed securities indefinitely (MBS) from financial institutions, will keep interest rates at zero percent until at least 2015, will make additional purchases if the employment picture doesn't improve, and in general will maintain an stimulative policy for a "considerable time."

The announcement sent stock and commodities prices soaring, and the U.S. dollar plummetting, as the Fed gave a clear indication that ZIRP (zero-interest rate policies) and monetary stimulus will be the new normal going forward. 

Although the announcement would seem to fall short of the expectations many had — that the Fed would make asset purchases totaling upwards of $400 billion over the coming months — the open-ended nature of the Fed's latest action makes it clear that more monetary stimulus is not only possible, but probable.

So what exactly did the Fed just do ... what is this whole policy all about? Well, Quantitative easing (QE) is an unconventional monetary policy used by central banks to stimulate the national economy when conventional monetary policy has become ineffective. A central bank implements quantitative easing by buying financial assets from commercial banks and other private institutions with newly created money, in order to inject a pre-determined quantity of money into the economy. This is distinguished from the more usual policy of buying or selling government bonds to keep market interest rates at a specified target value. Quantitative easing increases the excess reserves of the banks, and raises the prices of the financial assets bought, which lowers their yield.

The expression "QE2" became a "ubiquitous nickname" in 2010, usually used to refer to a second round of quantitative easing by central banks in the United States. Retrospectively, the round of quantitative easing preceding QE2 may be called "QE1." Similarly, "QE3" refers to the third round of quantitative easing, announced today, following QE2.

Blah, blah, blah. 

Here's a video that would likly do this question more service: 

That's QE.