QE2 and Stimulus round 2

Last week, we heard a number of reports on either quantitative easing 2 by the Fed or a call for a new stimulus program by the govt. - one a monetary and the other a fiscal tool to get the economy out of deflationary tendencies. all these people talk about such tools without considering the fundamentals behind the economy's current turmoil. QE2 would mean that the Treasury would buy more Treasury securities to add to it already bloating balance sheet and convert it into monetary units at bank deposits. The idea is that the banks would lend this money into the economy and fuel growth - but the banks already have a trillion dollars that they have kept in fed custody and are not lending out. Why would the banks lend out a new increase in deposits.

The QE2 is a way of printing money to finance the govt deficit - the govt borrows money from the market and issues Treasury securities. The Feds then buy those T securities and give money back in a sense to the initial lenders. Before the Feds bought the Treasury securities, the money was borrowed from one and spent by the other. With the Fed buyout, the govt has essentially gotten free money from the printing press of the Feds. A continual QE2 with deficit spending would steadily increase money supply and so should fuel inflation. But inflation also requires consumers to spend on things that is in short supply and must be able to borrow to spend the money. In an economy with bank lending controlled by the govt., this can be done by doling out free money to the consumers or a select section of the population and this happens in a lot of countries. The free money is then used to demand a lot of products and services, creates a supply shortage and shoots up inflation. But in the US, the banks are not going to lend free money after the mortgage crisis they have gone thru recently. Even with record low interest rates, a lot of people can't qualify for a mortgage loan because it has to be backed by a decent income and down payment - which doesn't exist for a lot of people. All the policy makers should think about the fundamentals of the economy and not just look at the next fiscal or monetary tool. The last monetary tool created the mortgage mess, shot up prices way beyond people's income generating capacity and we are trying all we can to keep it at that high level.