The US Federal Reserve is obviously following the creed of Tagore?s Ekla Chalo. The extraordinarily vocal criticism, in the run-up to this weekend?s G20 Summit, even from as august an individual as Germany?s finance minister, of the Fed?s $600 billion large-scale asset purchase (LSAP) programme, popularly dubbed QE2 (Quantitative Easing 2), conjures up an image justifying the Chairman?s nickname ?Helicopter Ben?. What exactly does QE2 entail? The Fed intends to spend $70 billion a month buying long-dated US securities, for the next 6 months, in addition to the $300 billion reinvestment of principal payments of earlier debt issues. Not as widely noted, Japan had, just a few days before, also announced a smaller-scale intervention but whose scope includes a much wider range of financial instruments (including equities, which might be dubbed qualitative easing).

QE2 is being hyphenated, rightly so, to the concerns on currency wars potentially adding to global funds imbalances, but the focus of the dissent has essentially centred on its liquidity and inflationary potential. The overt intention of the expansion is to influence yields, but more subtly (and left unsaid) is probably to keep the dollar weak, in the hope of maintaining US export competitiveness (although a strong currency might be equally beneficial to corporate profitability given the extent of US companies operating overseas and repatriating profits, although this is unlikely to be of comfort to Main Street).

A sharp rally in many commodities prices immediately following the Fed?s announcement can hardly have been a coincidence, although part of the increase must have been due to news of strong growth in China, India and other emerging markets. The price of crude has moved up sharply to close to $87/barrel; prices of industrial and commodities, whose trade is mostly denominated in dollars, have also moved up sharply. Copper, nickel and other industrial input prices have increased by about 4%.

What are the prospects of this LSAP programme working? Will the liquidity infusion have the desired effect on incentivising borrowers to borrow more? Or will it merely have the effect of pushing these funds to emerging markets shores?

One, in terms of the explicit targets of the intervention, yields across various maturities have been documented in some studies to have fallen as much as 50 basis points post the intervention but the counter-findings make the end-result quite ambiguous. Whatever the effects on interest rates, have the programmes had the desired effects of increasing borrowing, both among corporates and households? Apparently not. A recent credit survey noted that US consumers have reduced their outstanding debt, both mortgage and others, by nearly a trillion dollars over the past two years although the pace of reduction is falling. Lending standards also tightened in the wake of rising delinquencies post the crisis, are impeding new debt. Lending to small businesses also remains weak.

The other way of looking at this is in terms of liquidity. A general dissatisfaction with QE1 seems to have been that the Fed?s liquidity infusions to banks were promptly turned around and placed as excess reserves with the Fed, instead of being on-lent as credit to potential borrowers. This is probably not true. Although it is difficult to track the flow of funds, an indicative statistic from Fed data suggests that while liquidity injection over the period December 2008 to early November was about $1.5 trillion, the so called ?excess reserves? with the Fed of depository institutions (i.e., banks) was only about $120 billion. Since there has been little by way of a sharp rise in US credit offtake, an educated inference would be that a substantial part of the residual would have found its way into attractive investment destinations.

At the end of it all, do we really know what?s in store for us? No. On the whole, it is likely that the effects of a rise in commodity prices following a continuing dollar weakness will be a more immediate threat in the near term, compared to a surge in portfolio capital flows. Emerging economic weakness in Europe might gradually blunt some of the weakness going forward in 2011. A large current account deficit due to strong domestic demand (and rising costs of imported commodities) will absorb some of the presumed higher capital flows, but this certainly cannot persist for long.

As a somewhat didactic coda to the arguments above about the potential asset markets inflating effects of QE2, the RBI governor stated in his recent post policy analyst interaction that RBI would (only) respond to asset bubbles financed by bank credit. This is important from a policy perspective. Of course, it is difficult to distinguish the source of funds (given their fungibility), but the principle is sound and echoes Prof Alan Blinder?s arguments at the recent Jackson Hole Conference that sought to distinguish between equity and debt bubbles (for instance, the Dotcom bubble and the leverage induced recent one). For the former, the best policy is staying out and ?mopping up after. But for debt-financed bubbles, especially if they are bank-financed, it makes sense to intervene early to limit the bubble, though that intervention should probably be more with supervisory weapons than with monetary policy?. This stance has important implications for the structure of regulatory oversight, since a central bank?s information advantage as a banking regulator in managing debt driven asset bubbles is an argument for an integrated monetary policy and banking supervisory role. More on this later.

The author is senior vice-president, business & economic research, Axis Bank. These are his personal views

* Apologies for plagiarising Governor Kevin Warsh