2.6.2 Monetary Policy and Quantitative Easing

Question 1

what is quantitative easing

Answer 1

a central bank uses quantitative easing to increase the supply of money in the banking system to encourage commercial banks to lend at cheaper interest rates to small and medium sized businesses

Question 2

is quantitative easing a form of expansionary or contractionary monetary policy

Answer 2

expansionary - has been used to stimulate AD at a time when interest rates have fallen to historically low levels

Question 3

explain how quantitative easing works (simplistic)

Answer 3

• the central bank buys assets like government bonds from commercial banks and other financial institutions
• the banks get cash in return for selling bonds
• this increases the amount of money in the financial system and encourages banks to lend more and consumers and businesses to spend more

Question 4

why is quantitative easing used

Answer 4

economy may be in a liquidity trap - low interest rates but people remain unwilling or unable to borrow

Question 5

give an example of when quantitative easing has been used

Answer 5

• after the 2008/09 recession, consumer spending and business investment was low
• MPC cut interest rates from 5% to 0.5%
• this did not sufficiently boost AD, so QE was used

Question 6

what is a bond

Answer 6

governments usually borrow by issuing bonds (effectively an I Owe You note)
can be sold on primary or secondary markets

Question 7

what happens when the bond matures

Answer 7

the government pays the holder the face value of the bond

Question 8

what is also paid to the owner of the bond

Answer 8

interest

Question 9

what is quantitative tightening

Answer 9

the opposite of quantitative easing - aims to reduce the amount of money in circulation and to increase market interest rates

Question 10

explain fully quantitative easing

Answer 10

• the central bank creates electronic money to buy bonds from financial institutions
• there is increased demand for bonds, causing their market price to increase, decreasing their yield
• banks have more funds for lending as well as lower rates of interest
• this should increase consumption and investment, boosting AD

Question 11

describe the relationship between the market price of a bond and its yield

Answer 11

inverse

Question 12

what are the positives of quantitative easing

Answer 12

• gives central banks an extra tool of monetary policy so can help in a liquidity trap
• helps to lower the threat of deflation (minimises fall in real GDP)
• lower long-term interest rates have kept business confidence higher
• can lead to a depreciation of the exchange rate (greater supply), improving price competitiveness of exports

Question 13

what are the negatives of quantitative easing

Answer 13

• may contribute to rising wealth inequality due to surging house prices
• increase in money supply may cause inflationary pressure
• no guarantee that higher asset prices lead to higher consumption (especially if confidence is low)
• there are concerns banks and economies are becoming too dependent on QE (particularly in Eurozone)

Question 14

what can rising wealth inequality lead to

Answer 14

worsens geographical immobility

Question 15

what can be used to evaluate QE

Answer 15

• uncertain time lags and impact of QE in real economy
  -BoE is now a major holder of government debt
• economy may become too dependent of cheap money