When Ben Bernanke shows you the money

All eyes are on the United States Federal Reserve as the possibility of double dip recession in the world’s biggest ($14 trillion) economy becomes lot more real. Having cut interest rates to near zero, the only option before the US central bank is another round of quantitative easing – a.k.a. printing money. Here's what it really means:

At issue is the slow pace of economic rebound

But the weakness in the economy has persisted despite those measures; so the Fed’s Board of Governors has pursued a policy designed to stimulate the economy called Quantitative easing.

As of August 9 the prime rate was 3.0-3.25% and the discount rate was 0.5%.

How does quantitative easing work?

When the federal funds rate is already close to zero, the Fed can’t cut it further to stimulate economy, so one of its last options is to inject money into economy directly.

• In agreement with the Treasury, the Fed creates a large sum of money by electronically crediting its own bank account

• The Fed uses that cash to buy govt bonds from commercial or outside sources: banks, insurers, pension funds

• Banks and firms selling the bonds may use the proceeds to invest in new ventures or lend to individuals or other cos

• If lending is more active, interest rates on loans should drop; more money is spent and the economy picks up

• In theory, when the economy has bounced back, the Fed would sell the bonds it bought & then destroy the cash it gets back

In long term no actual extra cash would have been created.

Does quantitative easing involve the printing of money?

No. Each year, the U.S. Treasury places an order for the currency it expects economy will need, & Bureau of Engraving & Printing prints the required denominations; Quantitative easing uses electronic credits: no new paper money is printed.

Of all of the new bills printed each year, 95 percent is used to replace bills already in circulation, or removed because of age or damage.

What does quantitative easing mean for India?

Saugata Bhattacharya, Chief Economist, Axis Bank: At the time when commodity prices are coming down, this will push up prices. Emerging markets may be hurt.

Sunil Sinha, Senior Economist, CRISIL: Extra money will be disastrous, in particular for emerging economies like India. It will fuel inflation and hit growth