Quantitative easing (QE)

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Quantitative easing (QE) is an unconventional monetary policy used by some central banks to stimulate their economy when conventional monetary policy has become ineffective. The central bank buys government bonds and other financial assets, with new money that the bank creates electronically[1], in order to increase money supply and the excess reserves of the banking system. This action also raises the prices of the financial assets bought, which lowers their yield (as long as the yield is above zero).[2] Quantitative easing shifts monetary policy instruments away from interest rates, towards targetting the quantity of money. However the goals of monetary policy (including inflation targets) remain unchanged.[3]

Expansionary monetary policy normally involves a lowering of short-term interest rates by the central bank through the buying of short-term government bonds (termed open market operations).[4][5][6][7] However, when short-term interest rates are either at, or close to, zero, normalmonetary policy can no longer function as the purchase of short-term government bonds will no longer lower interest rates. Quantitative easing may then be used by the monetary authorities to further stimulate the economy, by expanding the excess reserves in the banking system and lowering interest rates further out on the yield curve.[8][9] Risks include the policy being more effective than intended or of not being effective enough, if banks opt simply to sit on the additional cash in order to increase their capital reserves in a climate of increasing defaults in their present loan portfolio

Amounts

The US Federal Reserve held between $700–$800 billion of Treasury notes on its balance sheet even before the recession. In late November 2008, the Fed started buying $600 billionMortgage-backed securities (MBS).[25] By March 2009, it held $1.75 trillion of bank debt, MBS, and Treasury notes, and reached a peak of $2.1 trillion in June 2010. Further purchases were halted since the economy had started to improve. Holdings started falling naturally as debt matured. In fact, holdings were projected to fall to $1.7 trillion by 2012. However, in August 2010 the Fed decided to renew quantitative easing because the economy wasn’t growing robustly. Its goal was to keep holdings at the $2.054 trillion level. To maintain that level, the Fed bought $30 billion in 2-10 year Treasury notes a month. In November 2010, the Fed announced it would increase quantitative easing, buying $600 billion of Treasury securities by the end of the second quarter of 2011.[26]

QE2

The expression ‘QE2’ has become a “ubiquitous nickname” in 2010, usually used to refer to a second round of quantitative easing by central banks.[32]

Process

Ordinarily, a central bank conducts monetary policy by raising or lowering its interest rate target for the inter-bank interest rate. The central bank achieves its interest rate target throughopen market operations – where the central bank buys or sells short-term government bonds in exchange for cash.[5][7] When the central bank disburses or collects payment for these bonds, it alters the amount of money in the economy, while simultaneously affecting the price (and thereby the yield) for short-term government bonds. This in turns affects the interbank interest rates.[33][34]

In some situations, such as with very low inflation, or in the presence of deflation, the central bank can no longer lower the target interest rate, as the interbank interest rates are either at, or close to, zero.[8][9] In such a situation, referred to as a liquidity trap, quantitative easing may be employed to further boost the amount of money in the financial system.[10] This is often considered a “last resort” to stimulate the economy.[35][36]

Steps

  1. The central bank has previously targeted an extremely low rate of interest, near or at zero percent.
  2. The central bank credits its own bank account with money it creates electronically.[10][37]
  3. The central bank buys government bonds (including long-term government bonds) or other financial assets, from commercial banks or other financial institutions, with the newly created money.[10][37]

Effectiveness

According to the IMF, the quantitative easing policies undertaken by the central banks of the major developed countries since the beginning of the late-2000s financial crisis, have contributed to the reduction in systemic risks following the bankruptcy of Lehman Brothers. It has also contributed to the recent improvements in market confidence, and the bottoming out of the recession in the G-7 economies.[39]

Economist Martin Feldstein argues that QE2 led to a rise in the stock-market in the second half of 2010, which in turn contributed to increasing consumption and the strong performance of the US economy in late-2010.[40]

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About GREGinSD

A Generation X|Y'er that resides in beautiful San Diego, Ca.
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