Have you noticed that in the world of business, there always seems to be a buzz word making its rounds? Terms like double-dip recession, inflation, unemployment, stimulus, and if we go back a little further, too big to fail, toxic assets and the popular qualifier, "in these economic times …"

Now that we've taken a trip down economic memory lane, let's crown the economic buzzword for September and October of 2010: quantitative easing! Since the Fed will not officially address this issue until their November meeting, it will undoubtedly be front page news into November as well. (To learn more, see Formulating Monetary Policy.)

IN PICTURES: Consumer "Fads" That Haven't Faded

What Is It?
Have you noticed that these financial fad terms make their away through media outlets faster than the definition? If you don't know what quantitative easing is, you're not alone. Here's an easy one line definition: The government buys stuff to stimulate the economy.

A Little More Detail
The Federal Reserve (the Fed) is charged with keeping the economy healthy. Like the blood in your body, there is a flow of money that travels from the Fed through the banks, in to your wallet, out to businesses, back to banks and back to the Fed to start the process again. If this process becomes disrupted, it causes severe problems in the economy, just as a clogged artery could cause a heart attack.

If the banks aren't lending money, this flow slows or stops. If the consumer is saving money instead of spending it, businesses aren't seeing a flow of money which causes disruption. Saving is great for our personal finances, but large-scale saving hurts business. The Fed attempts to prevent blockages from occurring.

The Fed does this in two ways. The first is with interest rates: if the flow of money is restricted, they lower the interest rate to encourage consumers to buy and borrow and banks to lend. Right now, the flow is so disrupted by banks not lending money, high unemployment, and more Americans saving that The Fed currently has interest rates at nearly 0%. This means that they have maxed out this tool since interest rates cannot directly go below 0%. (Learn more about the government and the economy in Top 6 U.S. Government Bailouts.)

When this happens, the Fed can set in to motion another tool called quantitative easing. This is simply the government buying assets. They may purchase bonds, T-bills, mortgages or other types of assets. And they do it on a grand scale! QE2 (Quantitative Easing, round two) would pump $1 trillion in to the economy if estimates are correct.

The purchase of these assets cause interest rates to fall, which further stimulates the economy, at least in theory.

IN PICTURES: Top 6 Uses For Bonds

Problems with QE
In order for the Fed to purchase these assets, they have to print more money. OK, they don't actually print it, there's a 21st century way of activating it. Printing more money eventually lowers the value of the dollar and could cause an inflation problem later on.

Next, economies don't normally respond well, in the long term, to artificial engineering. Driving the value of the dollar down could drive up the cost of commodities. According to Robert Lenzner, senior reporter for Forbes Magazine, we can already see these false valuations or "bubbles" by looking at the recent run up in the price of gold.

The other problem with the price of commodities artificially rising is that the average consumer could end up paying more for basic essentials like wheat, sugar, coffee and pork, just to name a few. Remember when the price of gasoline went to $4 per gallon? If the prices we pay for essentials rises, the stimulation of the economy is offset by higher costs.

The Bottom Line
Anything with government roots will have passionate supporters and equally passionate dissenters. We've already had one round of quantitative easing and judging by Bernanke's comments in October, a second round of quantitative easing, being dubbed "QE2" by the financial media, is on the way. (For more, check out 4 Government Interventions: Did They Work?)

For the latest financial news, see Water Cooler Finance: The Beginning Of A Foreclosure Crisis?

Related Articles
  1. Investing

    Which GOP Candidate Brings What to the Table?

    What are the major GOP presidential candidates' economic plans and how do they differ?
  2. Economics

    These Will Be the World's Top Economies in 2020

    Discover the current economic forces that are anticipated to significantly shift the landscape of the world's most powerful economies over the next decade.
  3. Fundamental Analysis

    Emerging Markets: Analyzing Colombia's GDP

    With a backdrop of armed rebels and drug cartels, the journey for the Colombian economy has been anything but easy.
  4. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  5. Economics

    Is the U.S. Economy Ready for Liftoff?

    The Fed continues to delay normalizing rates, citing inflation concerns and “global economic and financial developments” in explaining its rationale.
  6. Economics

    What's the 1913 Federal Reserve Act?

    The 1913 Federal Reserve Act was a pivotal congressional act that helped establish the Federal Reserve System as it exists today. It is one of the United States financial system’s most influential ...
  7. Investing News

    Could a Rate Hike Send Stocks Higher?

    A rate hike would certainly alter the investment scene, but would it be for the better or worse?
  8. Economics

    Open Market Operations vs. Quantitative Easing

    How does the Fed's implementation of Quantitative Easing differ from its more conventional open market operations?
  9. Investing Basics

    Reserve Bank of India Cuts Interest Rates

    On September 29, 2015, The Reserve Bank of India cut policy interest rates (or the repo rate) by a higher-than-expected 50 basis points, to stimulate domestic demand and to lower borrowing costs.
  10. Professionals

    Will Interest Rates Rise at the Next Fed Meeting?

    Everyone wants to know what the Federal Reserve will do next, but the Fed doesn't even know what it's next move will be.
  1. How does quantitative easing in the U.S. affect the bond market?

    It is not entirely understood just how much, or even in what direction, the Federal Reserve's quantitative easing, or QE, ... Read Full Answer >>
  2. Who decides to print money in Canada?

    In Canada, new money comes from two places: the Bank of Canada (BOC) and chartered banks such as the Toronto Dominion Bank ... Read Full Answer >>
  3. Who decides when to print money in India?

    The Reserve Bank of India, or RBI, manages currency in India. The bank's additional responsibilities include regulating the ... Read Full Answer >>
  4. Is Japan an emerging market economy?

    Japan is not an emerging market economy. Emerging market economies are characterized by low per capita incomes, poor infrastructure ... Read Full Answer >>
  5. How is the Federal Reserve audited?

    Contrary to conventional wisdom, the Federal Reserve is extensively audited. Politicians on the left and right of a populist ... Read Full Answer >>
  6. Who decides when to print money in the US?

    The U.S. Treasury decides to print money in the United States as it owns and operates printing presses. However, the Federal ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  2. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  3. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  4. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  5. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  6. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!