Quantitative easing Flashcards
(7 cards)
when is quantitative easing used
when traditional approaches to monetary policcy have failed
why might monetary policy have failed
- 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
how does quantitative easing work
💰 Increasing Money Supply
The central bank buys financial assets (such as government bonds) from banks →
This injects money into the banking system →
The banks now have more reserves and liquidity to lend →
This increases the overall money supply in the economy.
💵 Lowering Interest Rates
Buying assets increases the demand for those assets (e.g., government bonds) →
As demand for bonds increases, their prices rise and yields (interest rates) fall →
Lower yields lead to lower interest rates in the economy →
This encourages borrowing and spending by consumers and businesses.
🏦 Stimulating Bank Lending
Banks have more reserves and liquid assets following QE purchases →
With increased reserves, banks are more willing to lend to businesses and consumers →
More lending results in increased spending and investment →
This supports economic activity and helps to alleviate credit constraints.
💹 Encouraging Investment and Asset Prices
QE pushes down interest rates, making it cheaper to borrow money →
Lower interest rates encourage investment in capital projects and business expansion →
It also makes assets like real estate and stocks more attractive →
This raises asset prices, providing a wealth effect that boosts consumer confidence and spending.
what does the interest rate on a government bond represent
the return for an investor but the cost of borrowing to the issuer
how does the govt bond prices impact different groups
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
disadvantages of QE
🏚️ Asset Price Inflation
QE increases demand for financial assets (e.g., bonds, stocks) →
This raises asset prices, leading to higher valuations in financial markets →
The wealth effect benefits asset holders, but it exacerbates inequality →
Those without assets or savings may see fewer benefits, widening wealth disparities.
📉 Potential for Excessive Risk-Taking
Low interest rates from QE make borrowing cheaper →
This encourages businesses and individuals to take on more debt →
With lower yields on safer assets, investors may take riskier investments to seek returns →
This could lead to speculative bubbles or financial instability in the long run.
🔴 Diminishing Returns Over Time
Repeated QE measures inject liquidity into the economy →
The initial impact might boost growth and lending, but the effect weakens over time →
Markets and businesses may become accustomed to QE and less responsive to its impact →
The effectiveness of QE in stimulating the economy could decrease with continued use.
💸 Future Inflationary Pressures
QE increases the money supply by injecting liquidity into the economy →
If the economy recovers and spending rises too quickly, the excess money can lead to inflation →
Higher inflation erodes the purchasing power of money, harming consumers →
To counter inflation, the central bank may need to raise interest rates, which could slow economic recovery.
advantages of QE
💰 Stimulating Economic Growth
QE increases the money supply by buying financial assets →
This injects liquidity into the banking system, encouraging lending and borrowing →
Lower interest rates make loans more affordable for consumers and businesses →
This increased spending and investment can stimulate economic growth and reduce unemployment.
📉 Lower Borrowing Costs
QE raises demand for bonds, leading to lower bond yields →
This lowers long-term interest rates for mortgages, loans, and business credit →
Cheaper borrowing costs encourage investment in businesses and infrastructure →
Consumers benefit from lower mortgage and loan payments, boosting disposable income.
🏚️ Supporting Asset Prices and Wealth Effect
QE increases demand for financial assets such as bonds and stocks →
As asset prices rise, investors experience capital gains →
The wealth effect can boost consumer confidence and spending as people feel wealthier →
This can help businesses by stimulating demand for goods and services, supporting economic recovery.
🏦 Preventing Deflation
QE increases the money supply, boosting liquidity in the economy →
More money circulating helps maintain demand for goods and services →
This reduces the risk of deflation, which can lead to falling wages and lower spending →
By preventing deflation, QE helps to maintain stable prices and avoid a negative economic spiral.
