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Q&A quantitative easing

A guide to quantitative easing. Everything you need to know.

What is quantitative easing?

aA central bank buys large amounts of assets - in this case bonds backed by housing mortgages - in an effort to bring down interest rates and boost the economy. The US Federal Reserve has tried quantitative easing twice before, thus earning this round the designation QE3.

How does it work?

To buy bonds, the Fed essentially creates money, paying for its purchases by crediting the accounts of banks it buys bonds from. That's a clue as to how it works - as money in their Fed accounts earns the paltry quarter-of-a-percentage point in interest the Fed pays, banks may be keener to lend to companies and people. If companies use that money to buy equipment, and households buy homes and cars, the economy gets a jump. Fed bond-buying also helps by pushing down borrowing costs. Because the Fed is buying mortgage-backed bonds, the purchases act to directly lower the cost of borrowing to buy a home.

Why is the Fed doing it?

By lowering borrowing costs and spurring banks to lend, the Fed hopes to induce more spending and eventually set the stage for more hiring. This time around, the Fed tied its bond-purchase programme explicitly to jobs, saying it will keep buying bonds until it sees a substantial improvement in the labour market.

How well did it work in the past?

Most studies show that quantitative easing does reduce borrowing costs, as measured by the yield on 10-year Treasuries. Studies are less clear on how much this translates into real economic improvement, such as the creation of jobs. One model developed last year by John Williams, the Federal Reserve Bank of San Francisco chief, suggested the Fed's second round of bond-buying - US$600 billion (Dh2.2 trillion) worth - generated 700,000 jobs.

What are the risks?

Buying bonds expands the Fed's balance sheet. While the central bank says it will be able to shrink its giant balance sheet - $2.85 trillion before its latest round of buying bonds - without sparking inflation, it has never done anything like it before. Critics also say bond buying enables Congress and the president to avoid dealing with looming fiscal problems by giving them a handy buyer for the nation's debt. Politicians in other countries complain that it cheapens the dollar, hurting their exports, and floods their economies with capital that is hard to absorb.

* Reuters