The Fed recently announced it will buy $600 billion worth of government bonds over the next eight months to stimulate the economy — and the markets rejoiced.

But let’s be clear here, we’re not stepping onto a cruise liner to prosperity. This trip might be more like a Jeep ride in the Rockies.

Why did they do it?

The Fed has two key goals: full employment and stable prices. It has a bunch of tools in its toolkit to achieve these goals, and it tends to try them out one at a time to stimulate our economy. 

The first (and most commonly used) tool is the lowering of target (short-term) interest rates. This creates an eased environment. It’s cheaper to borrow money, and that in turn encourages business and consumer purchases, which trickles down to more robust economic activity on the whole.  

The Fed already used this tool. That’s why the rates are now at near zero, and the tool is worn out. It’s time to dig back into the kit and uncover a more unconventional strategy to help lower long-term interest rates.

Tool No. 2 is the purchase of treasury bonds, which pushes prices up, accomplishes a direct injection of money into the economy, and pulls long term interest rates down. This should eventually trickle down to private financial institutions and in turn be passed on to the consumer.

This second tool has a name. It’s called quantitative easing, or QE2 — with the number two referring to a second round of easing (or the second tool the Fed has employed).

This time the move comes with a bit of controversy. What’s the big deal? The first round of easing was put in motion in November 2008 to stabilize the financial system. This time, however, we are not in the middle of financial crisis, and the Fed’s goal is to boost the sluggish economy.

When will we see results? 

Monetary stimulus measures take time — usually several months, quarters or longer. It’s not a weekend trip. We all will have to be patient as the stimulus works its way through the economy. 

What if it doesn’t work?

There is always someone who asks this question, isn’t there? Not everyone is an optimist. 

Those who oppose this strategy are concerned that it will trigger too much inflation (from the large amount of money injected into the system) and a depreciation of the dollar. I bet you wonder where the Fed will come up with the money to pay for the bond purchase. They literally just print more money.  

The proponents believe that, with the looming threat of a double-dip recession, deflation is our biggest concern. They contend that boosting the money supply to force inflation is the right thing to do. 

How will this affect my investments?

A stimulated and recovering economy is usually bullish for growth assets such as stocks, real estate, and commodities. Temporarily, if bond rates fall, bond investments may perform well. 

However, at some point, longer rates may rise. If you are a bond investor, you could be in for a rough ride. The policy is explicitly designed to keep rates low so that borrowers can obtain credit cheaply, so finding bonds with attractive yields will require some effort. 

The bottom line is: don’t pack your Bermuda shorts yet. QE2 is not a cruise liner. You might be smarter to get a helmet for this trip. 

Mystified by money? Ask Denisa and improve your financial literacy. Denisa Tova MBA, CFP®, CDFA is a Colorado Springs-based Certified Financial Planner and CEO of DaVinci Financial Planning. Submit financial questions to her at denisa.tova@gazette.com.