Quantitative easing

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John Jagerson

Quantitative easing is a monetary policy tool in which a central bank—like the Federal Reserve—floods the market with cash in an attempt to stimulate an economy in recession and to stave off deflation. The idea is that if the central bank floods enough cash into the market, it will set off the following chain of events:

1. Banks and other financial institutions will build up larger and larger cash reserves
2. Banks will finally decide to loosen their lending standards to utilize their excess cash
3. Individuals and companies will start getting the loans they are seeking
4. The economy will begin to recover as people and companies begin to spend again.Understanding Quantitative Easing

Quantitative easing involves flooding the market with cash. The question is...how does a central bank—like the Federal Reserve—flood the market with cash?

Quantitative easing requires the central bank to take the following three steps:

1. Cut the short-term interest rate to zero percent
2. Announce how long it will leave the short-term interest rate at zero percent
3. Begin buying long-term securities—like Treasuries, corporate bonds and asset-backed securities

Why Would the Federal Reserve Resort to Quantitative Easing?

It seems that during good economic times, all we hear about is how concerned the Federal Reserve is with inflation. We can't let the economy grow too fast....We can't let the monetary base get too big....We can't just print money—the Fed says.

But during bad economic times, all of that seems to change. And during really bad economic times, we even start to hear about quantitative easing. But what does quantitative easing do for the economy?Benefits of Quantitative Easing

Quantitative easing can help consumers, exporters and financial institutions find their way out of a recession and offers some of the following benefits.

1. Quantitative easing can lower longer-term interest rates by pushing down yields at the far end of the yield curve.
2. Quantitative easing can lower deflationary expectations by promising to keep interest rates low for an extended period of time.
3. Quantitative easing can stimulate exports by increasing the monetary base.

Connecting Quantitative Easing to Government Spending (fiscal budgetary security tools)

Although monetary and fiscal models are normally viewed separately, QE as a monetary tool is so similar to deficit spending that the two lend themselves to a common view based on their immediate purpose: each is concerned with national and global security--to prevent chaos in trade and tragedy among nationals working in their own country.

QE and DS create necessary demand to protect people and nations from economic crises that may bring casualties in very large number and very short order. Both can create demand without limit -- except for the purchasing power of money after they become effective.

Each can be partially controlled by ending them. When either has done more harm than good their common remedy is taxation to prevent hoarding and policing to prevent tax evasion.

Accordingly, QE and DS require intense monitoring while in progress -- preferably by extremely sophisticated data analysts with tools akin to those of a national security agency with the highest priority on effectiveness not their cost.

References

Video: Understanding Quantitative Easing. Learning Markets. Retrieved on 2009-01-24.

Speech: Chairman Ben S. Bernanke. The Federal Reserve Board (1/13/2009). Retrieved on 2009-01-24.

Quantitative Monetary Easing and Risk in Financial Asset Markets. The Federal Reserve Board (9/282004). Retrieved on 2009-01-24. Bold text