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Speeches by Federal Reserve officials indicate that they are actively trying to boost asset prices by
suppressing interest rates. However, on closer examination, it appears that a more likely explanation
for their Quantitative Easing program is to disguise their financing of the federal and state deficits
through outright printing of money. Implications for investors…

Background

The Federal Reserve in August announced its second program of large scale asset purchases, termed QE2 by the
financial community (Quantitative Easing, Part 2).

The objectives of this program were discussed in a letter by Federal Reserve Chairman Ben Bernanke in
the Washington Post: “What the Fed did and why: supporting the recovery and sustaining price stability”
(November 4, 2010).

“The FOMC decided this week that, with unemployment high and inflation very low, further
support to the economy is needed. With short-term interest rates already about as low as they can
go, the FOMC agreed to deliver that support by purchasing additional longer-term securities, as
it did in 2008 and 2009…

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock
prices rose and long-term interest rates fell when investors began to anticipate the most recent
action. Easier financial conditions will promote economic growth. For example, lower mortgage
rates will make housing more affordable and allow more homeowners to refinance. Lower
corporate bond rates will encourage investment. And higher stock prices will boost consumer
wealth and help increase confidence, which can also spur spending. Increased spending will lead
to higher income and profits that, in a virtuous circle, will further support economic expansion.”

The Federal Reserve has traditionally applied its interest rate policies to short-term rates by changing the
discount rate, the rate at which financial institutions can borrow directly from the Fed. QE2 is designed to
suppress interest rates further out on the yield curve.