2.6 Macro Policies Flashcards
What is process of QE
Buying Bonds and Assets: The central bank starts buying large amounts of bonds (usually government bonds) and other financial assets from commercial banks or financial institutions. By doing this, the central bank creates new money. For example, if the central bank buys $1 billion worth of bonds, it credits that amount to the bank’s account.
Money in the System: The commercial banks now have more money than before, and this increases the amount of cash circulating in the economy.
Lowering Long-Term Interest Rates: When the central bank buys a lot of bonds, it makes the price of bonds go up. Since bond prices and interest rates move in opposite directions, as the price of bonds rises, their interest rates (or yields) go down. This lowers long-term interest rates across the economy, making loans and mortgages cheaper for businesses and consumers.
Encouraging Lending and Investment: With lower interest rates, businesses are more likely to borrow money to expand, and consumers are more likely to borrow money to buy homes, cars, or other big items. This spending and investment help boost the economy.
Stock Prices and Wealth Effect: Because investors now have more money and lower returns on bonds, they may also move their money into riskier assets like stocks, which can drive up stock prices. This increase in asset prices (like homes or stocks) can make people feel wealthier, encouraging them to spend more money.
The Goal: The goal of QE is to increase the money supply, lower borrowing costs, and encourage spending and investment. This is all meant to stimulate economic activity when traditional methods (like lowering interest rates) aren’t enough.
What is the short run Phillips curve?
Inflation and Unemployment: The short-run Phillips curve shows a negative (inverse) relationship between inflation and unemployment.
Low unemployment = High inflation.
High unemployment = Low inflation.
Why Does This Happen?:
When unemployment is low, there are fewer workers available. Companies compete for a smaller pool of workers, which leads them to offer higher wages to attract employees.
As wages rise, companies pass those costs onto consumers in the form of higher prices (inflation). This creates a wage-price spiral.
On the other hand, when unemployment is high, there is more labor market slack, so wages don’t rise as quickly, and inflation tends to be lower.
