Quantitative easing is the process of central banks' increasing the supply of money by boosting excess reserves, typically by purchasing government bonds to raise prices and lower yield.
QE2, as it has become known, was announced by Fed Chairman Ben Bernanke in early November, as the United States central bank pledged to buy $600 billion in long-term treasuries over the next eight months. This in hopes of stimulating the economy and maintaining low interest rates to propel us a bit further along in this sluggish recovery.
Now, only a month later, is the European Central Bank (ECB) about to do the same thing?
What was actually announced?
The European Union has been in a free fall since Ireland officially became the second country (after Greece) to accept a bailout from a joint effort led by the EU and the International Monetary Fund. The bond markets essentially flew off the rails and the equity markets plunged, taking with them shares of the Bank of Ireland (NYSE: IRE) and Allied Irish Banks (NYSE: AIB). Like a runaway freight train, nervous speculators claimed Portugal and Spain would fall next, and hence went the share prices of Banco Santander (NYSE: STD) and Banco Bilbao Vizcaya (NYSE: BBVA), both Spanish banks. Even National Bank of Greece's (NYSE: NBG) stock price quickly plummeted, despite the fact that the EU and IMF announced a 4 1/2-year extension to Greece's loan maturity.
However, shares of three out of those four banks were up by more than 2% as of early this afternoon -- mostly because of an announcement by the ECB. Previously, the ECB was supposed to phase out its liquidity support to EU banks in early 2011. However, President Jean-Claude Trichet said that it was abandoning this time frame. Now there will be unlimited liquidity for EU banks "as appropriate," Trichet said.
At first, it seemed like a great idea -- markets certainly responded well. Yields on two-year Spanish bonds fell, and the equities mentioned above all seemed to rise in tandem.
However, many economists and analysts have been disappointed by the announcement, saying it lacked the substance and firepower they were hoping for. Some economists estimated that the ECB would buy trillions in public-debt securities, but so far, that has not come to fruition.
QE3?
No, so far, this isn't exactly quantitative easing. The ECB, according to Trichet, is "withdrawing all the liquidity that we are injecting." Essentially, they're telling the banks that there is money available, if it's needed.
Nevertheless, some analysts are calling for a European-style round of quantitative easing. By printing money and increasing reserves against known and unknown sovereign risks, the EU could shore up capital for many banks. I'm not sure exactly how the markets would react in Europe (the response to QE2 in the U.S. was definitely mixed), but it could stem the tide of uncertainty.
What do you think would be the best way to calm markets? Has the ECB done enough? Feel free to sound off in the comments section below, or if you're interested, check out The Motley Fool's new special free report, "3 ETFs Set to Soar During the Recovery."
