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US Fed bets big to create jobs

The US central bank on Thursday said it will launch a third round of bond-buying to stimulate the economy, purchasing $40 billion (Rs. 221,000 crore) of mortgage debt each month until the outlook for jobs improves substantially.

business Updated: Sep 14, 2012 23:29 IST

The bernanke gambit: inside the stimulus

The US central bank on Thursday said it will launch a third round of bond-buying to stimulate the economy, purchasing $40 billion (Rs. 221,000 crore) of mortgage debt each month until the outlook for jobs improves substantially.

We decipher the details of the so-called quantitative easing (QE) to stimulate the US economy.

What is QE3?
A 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 name QE3.

How well has it worked in the past?
* Most studies show that QE does reduce borrowing costs but not clear on how much of those translate into real economic improvement, such as the creation of more jobs.

* One model suggested that the Fed's second round of bond-buying - $600 billion worth - generated 700,000 additional jobs.


How does it work?
* To buy bonds, the Fed essentially creates money from nothing, paying for its purchases by crediting the accounts of banks from which it buys the bonds. That's a clue as to how it works - as money piles up in their Fed accounts, earning the paltry quarter-of-a-percentage point in interest that the Fed pays, banks may be keener to lend to companies and people. If companies use that money to buy equipment, and households use it to buy homes and cars, the economy gets a jump.

* Because the Fed is buying mortgage-backed bonds, the purchases act to directly lower the cost of borrowing to buy a home.

* In addition, some investors, put off by the rising price of the bonds that the Fed is buying, turn to other assets, like corporate bonds - which, in turn, pushes up corporate bond prices and lowers those yields, making it cheaper for companies to borrow - and spend.

Why is the Fed doing it?
By lowering borrowing costs and spurring banks to lend more, the Fed hopes to induce more spending and eventually set the stage for more hiring.