Central banks around the globe have made their intentions clear: Interest rates will be cut -even to zero - to revive their economies after perhaps the worst financial and economic crisis since WWII.
The Federal Reserve slashed the Fed funds rate to a range of 0% and 0.25%; not too long ago (August 2007) it was still at 5.25%. The ECB cut their rate from 4.25% to 2.5%. The Bank of England reduced rates to 1.50% - the lowest level of interest rates ever recorded in the UK - from a peak of 5.75%. The Bank of Japan reduced interest rates to 0.1%.
Thus, in the major economies of the world interest rates have been cut for all practical purposes to zero (and negative, if considered on a real basis).
But what if the extreme loose monetary policies do not work, i.e. kick start the economy? After all, interest rates can be dropped only to zero. The next best thing is Quantitative Easing (QE) which unlike interest rates is a limitless monetary tool.
Basically, QE does not focus on the price of money, i.e. interest rates, but its quantity. This is accomplished by issuing money from the printing press to purchase securities - anything from government bonds to corporate debt, even equities.
One significant indicator of QE is seen by the rapid expansion of the central bank's balance sheet. In this respect the Fed's balance sheet has tripled in the past year as they swapped US Treasuries for securities held by struggling banks to provide them with liquidity. Furthermore, they announced their intent to buy $500bn mortgage-backed securities.
Such monetary policies should be inflationary. But for now that is not the worry - deflation poses a much bigger threat and QE should counter the risks of a prolonged deflation outlook. When Japan used QE, it was too late. Deflation by then was very well entrenched. At least for now, it seems that the Fed is acting swiftly to prevent a similar economic environment that plagued Japan in previous decades.
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