Quantitative easing

Question 1

when is quantitative easing used

Answer 1

when traditional approaches to monetary policcy have failed

Question 2

why might monetary policy have failed

Answer 2

• eg increasing IR (failed in the great recession of 2009 when UK lowered interest rates to 0.5%
• may fail because of the low availability of credit, ther access of finance for commercial banks was low, finding it hard to raise finance to issue out loans
• consumer and business confidence was low - they were not v willing to borrow
• bands were less willing to lend money

Question 3

how does quantitative easing work

Answer 3

1. central bank creates money electronically and puts that extra money on its balance sheet
2. the money is used to buy financial assets from financial institutions, eg assests like govt bonds (the idea was to disincentivise ppl w money to buy these govt bonds, take them away, and give the suppliers institutions money
3. increased demand for govt bonds as central bank buying more of them, this pushes up their prices
   
   • as price of bond goes up, yield/IR goes down
4. financial institutions either loan this money out or invest in riskier corporate bonds or shares
5. prices of corporate bond increases as greater demand, IR decreases, accessing finance becomes cheaper and reduces cost of borrowing money
6. access to credit improves, general interest rates fall, increased incentive to lend at lower interest rates
7. stimulates borrowing, investment and spending, increased AD and growth

Question 4

what does the interest rate on a government bond represent

Answer 4

the return for an investor but the cost of borrowing to the issuer

Question 5

how does the govt bond prices impact different groups

Answer 5

the government - issuing money is cheaper now because yields are falling
- firms - for ppl and investors, yield is lower so there is a reduced incentive to hold government bonds

Question 6

disadvantages of QE

Answer 6

Inflationary Pressure

1. QE can lead to higher inflation if too much money is injected into the economy.
   - By increasing the money supply, QE may drive up aggregate demand excessively. If the economy is close to full capacity, this can result in demand-pull inflation.
2. Asset Price Bubbles
3. QE tends to inflate asset prices, such as stocks and property, disproportionately.
   - Lower interest rates and increased liquidity encourage investors to seek higher returns in financial and property markets, driving up prices artificially.
   - This can lead to unsustainable asset bubbles, which, when they burst, cause significant economic disruption and financial instability.
4. Income and Wealth Inequality
5. QE disproportionately benefits those who hold financial assets, exacerbating inequality.
   - As asset prices rise, wealthier individuals and institutional investors gain, while those without assets, often lower-income groups, see little to no benefit.
6. QE often leads to a weaker currency, which can provoke trade tensions.
   - By increasing the money supply, QE tends to lower exchange rates, making exports cheaper but imports more expensive. Competing countries may perceive this as an unfair trade advantage.
   - Currency wars and retaliatory policies can arise

Question 7

advantages of QE

Answer 7

1. Boosts Economic Activity
   - QE increases the money supply, stimulating borrowing and spending in the economy.
   - By purchasing government bonds and other financial assets, central banks inject liquidity into the banking system, encouraging banks to lend more to businesses and households.
   - This leads to higher consumption and investment, boosting AD , growth
2. Restores Financial Market Stability
   - QE helps stabilize financial markets during economic downturns or crises.
   - Central banks buying financial assets increases their prices and lowers yields, reducing borrowing costs and ensuring liquidity in key markets.
   - This calms investor fears and prevents panic, helping to maintain confidence in the financial system and avoid a credit crunch.(banks unwilling to lend)
3. Attracts Foreign Investment and Boosts Exports
   - QE can weaken a country’s currency, making exports more competitive and attracting foreign capital.
   - An increased money supply often leads to currency depreciation, as more of the currency is available in the global market. A weaker currency benefits exporters by making goods cheaper for foreign buyers.
   - This can improve the trade balance, increase export revenues, and create jobs, further supporting economic recovery.
4. Lowers Bond Yields and Debt Costs
   - QE helps keep bond yields low, reducing borrowing costs for governments, businesses, and consumers.
   - As central banks purchase bonds, demand increases, which raises bond prices and lowers their yields. This reduces interest rates across the economy.
   - Lower debt costs allow businesses to invest in growth and innovation, while governments can fund public services and infrastructure projects more affordably