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Explanation of Quantitative Easing (QE), how It Allows Central Banks to Make a ton of money? | Trading Cocktail

Quantitative Easing, How It Allows Central Banks to Make a ton of money?

Quantitative easing is a new way the Federal Reserve helps the economy when it’s in trouble. It boosts the money supply and lowers long-term interest rates, which makes it easier for banks to lend money to people. This helps the economy to grow, which is good for the country.

What Is Quantitative Easing (QE)?

Central banks buy long-term bonds from their member banks as part of quantitative easing (QE).  A lot of new money is coming into the economy because of the central bank’s purchase of these securities. This means that interest rates go down, making it easier for people to borrow.

It is a tool used by the Fed to make money more available. It is an expansion of the Fed’s open market operations, which is how it makes money more available. Interest rates can be lowered with other tools. The Fed uses QE after it has lowered the fed funds rate to zero. The Fed funds rate is the basis for all other short-term rates.


How The QE Works

When the Federal Reserve buys securities from its member banks, it pays them cash in return for assets like bonds. The excess funds might then be lent out.

The Fed also sets the reserve requirement for banks, which is the percentage of their funds they must maintain on hand versus what they lend out. Lowering the reserve allows banks to give out more money. Money supply expands when more money is sent out, allowing interest rates to decline. Lower interest rates encourage consumers to borrow and spend, boosting the economy.

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Explanation of Quantitative Easing (QE), how It Allows Central Banks to Make a ton of money? | Trading Cocktail

QE also stimulates the economy in other 3 ways.

Bond Yields Remain Low Due to Quantitative Easing

To fund expansionary fiscal policies, the federal government auctions off huge amounts of Treasurys.

As the Fed purchases Treasurys, demand rises, keeping Treasury rates low (with bonds, there is an inverse relationship between yields and prices).

All long-term interest rates are based on Treasurys. As a result, quantitative easing via Treasury purchases keeps auto, furniture, and other consumer debt rates low. Long-term, fixed-interest debt is the same way. The housing market is supported when mortgage rates are kept low. Low interest rates on corporate bonds make expansion more affordable for corporations.


QE Increases Exports and Attracts Foreign Investment

The value of the country’s currency is kept low by increasing the money supply. Foreign investors are more interested in U.S. stocks when the dollar is weaker because they can receive more for their money. It also lowers the cost of exporting.


Inflationary Consequences of Quantitative Easing

The sole disadvantage is that QE increases the Fed’s Treasury and other securities holdings. Before the financial crisis of 2008, the Federal Reserve’s balance sheet was less than $1 trillion. By July 2014, the figure had risen to about $4.5 trillion.

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