QE2 : Quick Analysis

All eyes are going to be on whether QE2 will do what it sets out to do. Especially emerging economies like India. If QE2 doesn't achieve it's goals to discourage saving by raising inflationary expectations, then what?  If this doesn't encourage enough spending to bring back unemployment to full employment levels, hence increase income and aggregate demand (AD), then what?

Here's my attempt at trying to answer this question with the little I know about applying Economic theory I learn in the classroom. If QE2 doesn't work in effectively raising prices, the economy will be stuck on the keynesian side of the short run aggregate supply curve (SRAS) (from AD to AD') where prices don't really change, and equilibrium output is way below the full employment level of ouput indicated by the long run aggregate supply curve (LRAS), which is what implies the so called recessionary gap (AE). This is where there is high unemployment, prices refuse to really decline (prices are sticky or inflexible downward on this side of SRAS, i.e. even though demand is low prices don't drop) and so there is no reason why demand and spending should ever go up from here and that just keeps going on and we reach e'. But if fiscal policy or monetary policy is aggressive enough things are different and the economy will be able to move the AD curve outwards to the desired extent.
(really sketchy graph, done on paint ;-) )

So what the fed essentially is trying to do is this: Usually when AD curve moves outward (from AD to AD''), equilibrium is at a higher output and clearly higher price level(inflation). On this part of the SRAS, no matter how the prices move, demand grows until we reach e''. So if it's hard to stimulate spending in times when nearly zero percent interest rate becomes ineffective in doing the same, we do the opposite, i.e. we try to shift the AD curve outwards by raisng infaltionary expectation first and then that should induce spending now (rather than later; basic aim of inflationary expectation). And this point is reached through the inlfationary gap (EB).

If QE2 doesn't achieve its objectives, then will it push up inflows into emerging economies like India? it's hard to tell. In the second quarter review RBI mentioned a very important point that factors apart from the interest rate differential are driving the current FII surge in our capital markets. We'll just have to wait and watch.

Can this be one of fed's last few chances to prove those people wrong, the ones who krugman claims use "shibboleths" to oppose fed's attempts to use inflation to bring about negative interest rates? Obama's streak of bad times just got worse, would this further reduce support for Bernanke's policies and give room for his opposers to make more noise?