Is QE3 Waiting in the Wings?

06/15/2011 8:00 am EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

It's going to take some time to see what the iimplications of QE2 have been, but it looks at this point that the reality fell short of the hopes, say Dan Sullivan of The Chartist.

With QE2 scheduled to end on June 30, economists and investors alike are debating the effect it has had, and how it will affect the recovery once it’s turned off.

QE2 followed the original Quantitative Easing that the Federal Reserve rolled out in 2008. The second round of stimulus, dubbed QE2, started in the fourth quarter of 2010, as the Fed stepped up its efforts to jump-start the sluggish economy.

When the plan was announced, the Central Bank pledged to buy $600 billion in long-term Treasuries and another $250 to $300 billion in Treasuries using earlier proceeds from mortgage-backed securities.

Some critics of the stimulus package believed the massive infusion of cash into the economy would lead to runaway inflation, or create future asset bubbles down the road.

Meanwhile, other critics argued that the easing simply wouldn’t work. After all, the Fed had already taken a number of similar measures, including keeping interest rates at almost zero, with nothing tangible to show for it.

Now, with QE2 ending next month, economists are once again arguing the merits of the plan. Liz Ann Sonders, chief investment strategist for Charles Schwab, points out that the money the Fed intended to help the recovery is not circulating throughout the economy.

Based on the M2 Velocity of Money Indicator, which is the ratio of gross domestic product to M2 money supply, consumers are not spending. The indicator fell to its lowest levels since 1991 in Spring 2009.

It has improved slightly in the following two years, but remains at very low levels. With all the money the Fed has pumped into the system, the indicator should be much higher.

Sonders notes, “Until that chart starts to turn up, substantial headway in improving the unemployment rate and raising wages will continue to be difficult. However, there are some glimmers of hope on that front as we are seeing banks’ willingness to lend expand.

"As banks lend more, and consumers and businesses put that money to work in the economy, we should see money rotating through the economy, increasing the velocity of money, and making the Fed’s program much more effective.”

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