Quantitative Easement 2021

Quantitative Easement and Tapering

Two financial terms that sound like Dr. Suess and your legal counsel cooked up in a New York polysci think tank.

Today we’re going to make them simple.

Quantitative Easement is when the Federal Reserve Bank buys our own Bonds, mostly MBS, or mortgage-backed securities. They buy 60-140 billion USD per month. When the Federal Reserve buys our own debt instead of other countries we can lend to ourselves and pay ourselves back at low interest rates. They also buy financial assets which increases liquidity and supports the prices of all financial assets.

It worked to keep our interest rates low during the 2007 financial crisis and now it’s being used again due to the recession caused by the COVID 19 global impact to stimulate our economy and manage government debt.

But it can’t go on forever. Inflation, global markets, GDP, job growth and non-artificial economic stimulus will bring about our next term, “Tapering.”

Tapering is when the FED MoM (month over month) gradually reduces the amount they buy their own bonds, usually in 20 billion USD increments until we no longer buy our own debt. They “Taper” the purchase of our own bonds because if they were to stop in one month the economic shock of not pumping money into our economy would theoretically cause market crashes and whiplash that could be economically disastrous.

Instead tapering allows our economy to recover gradually in other indexes like lumber, farm goods, manufacturing and other tangible sectors to get traction in our GDP, or Gross Domestic Product.

When tapering happens rates go up because it’s a sign the Fed is adjusting to inflation which should be tied to growth.

Remember this blog and video were made 2 weeks before the FOMC meeting – when they dropped the “Tapering” word rates went up .80 bps nationwide.

Stay tuned!

Quantitative Easement 2021

Introduction

Quantitative Easement is a monetary policy tool used by central banks to stimulate growth by increasing the money supply. The Federal Reserve System is the central bank of the United States and is responsible for implementing QE policies to manage monetary policy, including interest rates and asset purchases, to ensure economic stability. In this post we will make it simple.

Quantitative easing is a type of non-traditional monetary policy used by a central bank to stimulate growth. It’s large scale asset purchases of government bonds and mortgage backed securities to increase the money supply and lower interest rates. The goal of QE is to encourage spending and investment which leads to increased demand for goods and services, job creation and economic vitality.

History of Quantitative Easement

Quantitative easing was first introduced by the Bank of Japan in the early 2000s. But it was the Federal Reserve that popularized QE as a monetary policy tool during the 2007-2008 financial crisis. The Fed did QE1 in November 2008, QE2 in 2010, QE3 in 2012 and QE4 in 2020. The Federal Reserve’s balance sheet expanded significantly during each round of QE. Other central banks like the European Central Bank and the Bank of England also used QE to stimulate growth.

How Quantitative Easing Works in the Central Bank

The mechanics of QE is the central bank creating new money to buy assets from banks. The banks then lend the money to borrowers at attractive rates increasing the money supply and stimulating the economy. The central bank’s balance sheet expands from QE and the increased money supply can lead to lower interest rates and higher asset prices.

Central Banks and QE

Role of Central Banks in Implementing QE

Central banks play a pivotal role in implementing quantitative easing (QE) policies. As the primary monetary authority in a country, central banks have the unique ability to create new money and use it to purchase assets from commercial banks. This injection of liquidity into the financial system is designed to stimulate economic growth by lowering interest rates and increasing the money supply.

In the United States, the Federal Reserve is the central bank responsible for implementing QE policies. The Fed uses its balance sheet to purchase assets such as Treasury securities and mortgage-backed securities from commercial banks. This process increases the amount of bank reserves in the system, which in turn allows banks to make more loans and stimulate economic activity.

Other central banks, such as the European Central Bank (ECB) and the Bank of Japan (BOJ), have also implemented QE policies to stimulate economic growth in their respective regions. The ECB has used QE to purchase government bonds and other assets from European banks, while the BOJ has used QE to purchase Japanese government bonds and other assets from Japanese banks. These actions by central banks are crucial in maintaining economic stability and promoting growth during times of financial uncertainty.

Comparison with Other Central Banks’ QE Policies

The Federal Reserve’s QE policies have often been compared to those of other central banks, such as the ECB and the BOJ. While the overarching goals of QE policies are similar across central banks—namely, to stimulate economic growth and stabilize financial markets—the specific implementation and scope of these policies can vary significantly.

For instance, the ECB’s QE program has been larger in scope compared to the Fed’s, with the ECB purchasing over €2 trillion in assets since 2015. The BOJ’s QE program has also been substantial, with the BOJ purchasing over ¥500 trillion in assets since 2013. These large-scale asset purchases have been aimed at lowering interest rates and boosting economic activity in their respective regions.

In contrast, the Fed’s QE program has been more targeted, focusing on specific types of assets such as Treasury securities and mortgage-backed securities. The Fed has also been more aggressive in its use of QE, purchasing over $4 trillion in assets since 2008. This targeted approach has allowed the Fed to directly influence key areas of the financial market and support economic growth more effectively.

Effectiveness of Quantitative Easement in Monetary Policy

The effectiveness of QE is debated among economists. Some say QE has been successful in stimulating growth and financial stability while others say it has limited impact or even negative effects like increasing inequality and asset bubbles. Research shows QE has been effective in reducing long term interest rates and stimulating activity but its impact on inflation and employment is unclear.

The Impact of Quantitative Easing on Economic Growth

 

Risks and Side-Effects of QE

Moral Hazard and Reputational Risks

One of the significant risks associated with QE policies is moral hazard. Moral hazard occurs when financial institutions take on excessive risk because they believe that the central bank will bail them out if things go wrong. This can lead to a situation where banks engage in reckless behavior, such as making risky loans or investing in speculative assets, knowing that the central bank’s safety net is in place.

Another risk associated with QE policies is reputational risk. Reputational risk arises when the central bank’s actions are perceived as ineffective or even counterproductive. This can damage the central bank’s reputation and undermine its ability to implement effective monetary policy in the future. If the public and financial markets lose confidence in the central bank’s ability to manage the economy, it can lead to increased volatility and uncertainty.

In addition to these risks, QE policies can also have unintended side-effects. For example, QE can lead to asset price inflation, where the prices of assets such as stocks and real estate increase rapidly. This can create a bubble in the asset market, which can eventually burst and lead to a sharp decline in asset prices. Such a scenario can have severe consequences for the broader economy, leading to financial instability and economic downturns.

Overall, while QE policies can be an effective tool for stimulating economic growth, they also carry significant risks and side-effects. Central banks must carefully consider these risks and side-effects when implementing QE policies and be prepared to adjust their strategies as needed to mitigate these risks.