The Federal Reserve Board announced last week that it will engage in a policy widely referred to as “Quantitative Easing” or over the next six months. Since this will be the second time this policy is being used to combat the weak economy, it is being widely referred to as QE2.
QE2 is a policy that used to be called monetizing the deficit. Basically the Fed buys government debt, paying cash to the banks for the debt. This demand for the debt raises the price and lowers the interest rate. In addition, the Fed is providing cash directly to banks that they can go out and lend. So the idea is to push as much money as possible into the economy with the dual anticipated benefits of lowering interest rates and stimulating lending.
Will it work? Yes, but through its impact on confidence, not interest rates.
It’s hard to see how much of an impact this policy will have on interest rates. As the two charts below show, both Treasury note rates and mortgage rates are low, as low as they have been in decades. It is not clear how much lower they will go as a result of this policy. If the current level of interest rates is not stimulating more home sales a drop of an additional 25 to 50 basis points is not likely to have a major impact.
But one thing the policy is likely to do is boost confidence and low levels of confidence have been a constraint on the economy this year. There is a strong sense of frustration and uncertainty about this economic recovery. The Fed’s action will show that the Government remains committed to doing everything possible to ensure that the economy continues to grow and the recovery gets stronger. That commitment will have an impact. It is likely to help reduce the uncertainty that many feel about the direction of the economy. We have already seen that in the pickup in equity markets since the policy was announced. Higher stock prices will also help consumers feel wealthier and may stimulate some increase in spending from households.
Once businesses feel more confident they are more likely to use their strong profit performance to increase hiring in an effort to gain market share. This should lead to a stronger economic performance in 2011.
For the real estate sector it’s all about jobs and more confident businesses are more likely to increase hiring in the months ahead.
Senior Economist, Senior Managing Director, Research
Cushman & Wakefield