Last Thursday, the Federal Reserve announced that it would undertake another round of quantitative easing (QE), but this time a few things are different. Instead of having a set amount in mind, the quantitative part, it will buy $40 billion of securities, including mortgage-backed securities, until it has deemed that financial conditions have sufficiently improved. After $2.3 trillion in QE so far since 2008, how much will the Fed end up spending to meet its “improved” conditions, and what are the risks?

Inflation

Speculation on the amount abounds as different sides of the new measures talk about risks, benefits and possible pitfalls. Today Richard Fisher, president of the Federal Reserve’s Dallas branch said, “We have seen a sharp rise in inflation expectations. If you let this get out of hand, then I think we will have a market reaction,” underscoring a central problem in the bank’s new policy. With such large amounts of securities being purchased, and essentially new money being injected into the economy, inflation is a chief risk of the policy.  Current goals at the Fed have remained at 2 percent per year inflation, but this new open-ended policy places that goal in jeopardy, according to dissenting opinions.

Future Withdrawal

Though inflation may be one of the largest risks of the Fed’s new policy, one that may be just as dangerous and is certain to happen is the future withdrawal of the invested funds as the bank’s assets mature. As the bank buys securities and assets, those assets inject funds into the economy, but once those assets have reached maturity and the bank is forced to reclaim the lost funds, it will be removing capital from the market. The Fed cannotsimply leave the funds it has invested in the economy; instead those same funds which were meant to spur growth will now act as an anchor as private banks are forced to pay out. There is no doubt that the Fed will try to spread this process out over a significant period of time to ease the pain of removing capital, but in 2010 when the Fed halted its QE1 program, markets slipped during thesummer, and the Fed was forced to return to the program with QE2 and Operation Twist. Between now and the time when we have the “improved” conditions laid out by the Fed, a plan for steady withdrawal, as not to damage gains made, will have to be carefully crafted and executed so institutions and banks who have counted on QE since 2008 do not fall without it.

$85 billion a Month

Since 2008 QE has been purchasing a wide array of securities in order to help reduce short and long-term interest rates. The idea has been to spur economic growth by placing capital in banks and financial institutions that then could lend that capital to borrowers (corporations, businesses, new home owners etc.) at a much lower interest rate. But, after four years of the unprecedented purchasing program, unemployment is still above eight percent, we are $16 trillion in debt and net household income has remained nearly stagnant at 2008 levels. Now we are doubling down on a program which may or may not be helping the economy at a higher rate of $85 billion a month when including the Fed’s long-term purchasing program, Operation Twist. In fact, private banks are even having trouble organizing paperwork in order to process the purchases by the Fed, in part due to new regulations on the banking industry.

After all is said and done the unprecedented policy could help to improve economic conditions, but at what risk? Following Bernanke’s own advice, the real course of action is for Congress and the administration toaddress huge fiscal issues facing the country. A national debt of $16 trillion, a federal budget deficit of over $1 trillion, looming tax increases and the sequester all make up the fiscal cliff, which the Congressional Budget Offices says threatens to drop us back into recession. It is time for politicians in Washington to put economics before politics and take action, because while QE3 may not work, at least Bernanke is trying.