The Fed's Plan in Plain English

On Yahoo's TechTicker, Aaron Task sat down with Axel Merk of Merk Mutual Funds to discuss what the Federal Reserve's $600 billion treasury purchase announcement really means.

When asked, “Why is the Federal Reserve buying bonds?” Mr. Merk said, “It wants to lower interest rates, in the hopes that doing so will loosen the supply of credit and spur more economic activity,” adding that, “The central bank's main tool for reducing rates is to slash the short-term overnight lending that banks charge to one another, the so-called Federal Funds rate. Bring short-term rates down, and long-term rates tend to follow. In normal times, that's as far as the Fed usually goes.”

Given that rates are already as low as they can practically go, Mr. Merk illustrated the point that that is where quantitative easing (QE) comes into play, saying, “The Fed can also influence long-term rates by purchasing (or selling) long-term debt in the open market. When lots of people -- or one big buyer -- buy bonds at the same time, it drives prices up and interest rates down. As the nation's central bank, the Fed can create money and simply announce that it will buy large quantities of bonds.”

To see the whole informative interview, please click here.