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February 8, 2012

Could QE3 Be a Product of High Government Deficits?



In the debate of whether or not the Federal Reserve should initiate another round of quantitative easing, the influence of fiscal policy in the United States has not been discussed. Could it be that high government deficits, fueled by out of control spending, could pressure the Fed to QE3?

Let's look at Europe.

Europe's debt crisis has been fueled by high deficits, causing interest rates to rise. The only way for these interest rates to come down is for the governments to reduce borrowing or for investors to increase their purchases of government bonds. One way for those purchases to increase is via the Central Bank.

Depending on the next few quarters of economic activity, I could conceivably see the Federal Reserve intervening to keep interest rates low, via quantitative easing, to defend the massively irresponsible actions of the federal government. If economic growth gets stronger, however, what reason would the Federal Reserve give to buy government bonds?