December 11th, 2008
11:42 AM GMT
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LONDON, England - What do you if you're dealing with potentially the worst downturn in the post-war period, and the biggest financial crisis since the Great Depression?

What do you do if your job is to kick-start the world's biggest economy, but your normal tool - cutting official interest rates - isn't enough and you're fast approaching zero interest rates?

What you do is you go to unconventional means, you do what's called quantitative easing. And that's exactly what the U.S. Federal Reserve is doing.

The Fed is firefighting with several emergency programs aimed at easing the credit crisis. They include a commitment to buy $600 billion of debt tied to the housing market, and $200 billion to support business and consumer loans.

But the Fed can throw as much money at the problem as it needs, and has already more than doubled its balance sheet to $2.1 trillion. And that figure could soon rise to nearly $4 trillion, according to analysts.

Fed chairman Ben Bernanke has even been called "Helicopter Ben" after he gave a speech in 2002. In that speech he referred to the economist Milton Friedman who suggested once interest rates have been cut to zero, radical steps may be needed to infuse the economy with cash, and dropping money from a helicopter may be as good as any other method.

The Bank of Japan is the only major central bank in recent times to rely on quantitative easing. It used it to try and fight the economic malaise and deflation that plagued the economy in the 1990s - its so-called lost decade.

When consumers expect deflation they may hold off on making purchases, expecting they will be cheaper in the future, and that in turn only prolongs a recession.

The Fed, knowing what happened in Japan, is trying to make sure the United States doesn't have a similar fate. It has reacted much quicker.

It's still unclear if its strategy will ultimately work. And there are downside risks; all that extra money in the system could at some point lead to a resurgence of inflation.

That in turn could make foreigners less willing to invest in U.S. securities, which would lead to higher interest rates and a weaker dollar. There are also potential consequences for the budget deficit.

But for now, Bernanke and company at the Fed are not thinking about what happens down the road. Instead, they are focused on getting the U.S. economy back on track, and are willing to do whatever it takes to try and make that happen.

Do you think the Fed is taking the right course of action? Do you agree it could be storing up problems for later? I'm keen to hear your thoughts.



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