QE Flashcards
What is Quantitative Easing?
Quantitative Easing (QE) is a method of increasing the money supply in the economy in order to increase AD and thus boost growth and employment when traditional monetary policy easing has reached its lower bound or has failed to stimulate the economy due to banks not willing to lend or poor availability/high cost of credit. QE is a more direct and extreme avenue of monetary policy to overcome such issues working in this process. The central bank electronically creates new money and uses it to buy financial assets (mainly government bonds) from financial institutions. This drives up the price of bonds and reduces their yield. Financial institutions that have now have large amounts of cash reserves buy up other assets with better yields, once more driving up those prices and reducing yields. As yields (long term interest rates) across the economy fall, the coupon rates that financial institutions offer on their corporate bonds can also fall, reducing the cost of borrowing for them allowing them to offer lower interest rates on general loans and mortgages for households and businesses wanting to consume or invest. This encourages more borrowing for consumption and investment boosting AD and stimulating the economy in times of need.
What is quantitative easing?
Quantitative easing (QE) is an expansionary monetary policy where the central bank creates money to buy financial assets, mainly government bonds, from financial institutions to increase liquidity and stimulate the economy.
What is the potential negative impact of quantitative easing on inflation in the economy?
The potential negative impact of quantitative easing on inflation in the economy is that as spare capacity is exhausted, there is more competition for resources and pressure put on existing factors of production, increasing the prices of them. This puts upward pressure on prices and causes demand-pull inflation. Monetarists argue that with more money chasing the same quantity of goods and services, prices will rise to compensate, creating greater inflationary pressure.
Why may banks still not be willing to lend despite quantitative easing?
Banks, particularly in times of deep recession or financial crisis, are extremely concerned about their liquidity and profitability. Their willingness to take risks is extremely low, reducing their willingness to lend, even to relatively safe borrowers. Furthermore, even if banks are willing to lend, they may charge higher interest rates if they are averse to risk, reducing the borrowing incentives for consumers and firms, and thus the positive aggregate demand impact.
How does quantitative easing drive wealth inequality?
Quantitative easing drives wealth inequality because when financial institutions replace assets for cash from the central bank, this money goes into buying shares, bonds, or houses, driving up the prices of these forms of wealth. Consequently, owners of these assets will see a large rise in their wealth, widening the wealth gap between themselves and those who lack ownership of such assets.
What is the negative impact of quantitative easing on savers?
The negative impact of quantitative easing on savers is that as bond prices are driven up, those who have saved in government bonds or in pension funds where bonds are a major investment will receive a lower return. Furthermore, as long-term interest rates are driven down in the economy, even ordinary savers will receive lower rates of interest and thus lower returns, discouraging savers and saving.
