Understanding How Quantitative Easing Works | Investing Basics

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Understanding How Quantitative Easing Works

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by S. Wade Hansen

Definition: Quantitative Easing

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.

[To learn more about the goals of the Federal reserve and why it wants to stimulate the economy, check out our article and video on The Goals of the Federal Reserve.]

"Helicopter Ben" (Federal Reserve Chairman Ben Bernanke) indicated in a speech in 2002 that he would be willing to dump as much cash into the economy through quantitative easing as was necessary to stimulate growth.

Application: 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

[To learn more about what it means to cut interest rates to zero, check out our article and video on Understanding what it means when the Fed "cuts rates".]

2. Announce how long it will leave the short-term interest rate at zero percent

[To learn more about how the Fed gets interest rates to zero and keeps them there, check out our article and video on The Federal Reserve's Open Market Operations.]

3. Begin buying long-term securities—like Treasuries, corporate bonds and asset-backed securities

Continue to Part 2: The Benefits of Quantitative Easing.

Comments

Add New

Brad Wats - OK....and Then?

|2009-01-23 09:17:13

How does on counteract " Quantitative Easing" to avoid
hyperinflation?

Big Ben has already flushed out 2 trillion in new cash. What
happens when this new cash hits the market?

A.N.Other - Yes more importantly...

|2009-03-08 03:12:43

... how do you protect your investments and/or make use of the inflation rather
suffering from it?

swadehansen - Profiting from Inflation

|2009-03-09 08:03:30

One way to profit from inflation is to buy the iShares Treasury Inflation
Protection Securities (TIPS) exchange-traded fund (ETF). It's ticker is TIP. If
inflation starts to rise, the value of TIP will also rise.

Z.O.G.

|2009-03-20 01:07:54

People who are constantly talking about hyperinflation are confused. If you
print up $10 billion in currency and then bury it in your back yard, does it
cause inflation? NO!

The Fed has already lent about $800 billion in new
credit to the commercial banking system over the past year and a half, but the
banks are keeping almost all of this new credit money on deposit with their
regional Federal Reserve Banks. This new money has NOT been lent into
circulation by the commercial banks. That's why there has been no
"hyperinflation" and there never will be.

The American economic and
financial system is in a full-blown deflationary debt collapse, and nothing the
Fed can do will change that. :-)

AZREN - Quantitative Easing

|2009-03-20 13:49:18

Informative

eminence.unltd - Easing Fiat Currency Upon the Ignorant.

|2009-03-22 12:09:10

No point arguing about inflation or hyperinflation or even deflation. But
seriously people, money must have value. Yet not one currency, that I know of,
is currently backed by anything of value except the paper its printed on.
Currencies around the world are all being propped up, sustaining as a medium of
exchange, continually perpetuated by the blind faith and ignorance of the
majority of people who unwittingly and/or unknowingly are lead further astray.
QE cannot fix the economy. Paper as money is counterfeit, period. Just consider
the cost to print a sheet of $1.00 bills vs. $100.00 bills. THE COST IS THE
SAME! Central Banks do not fix economies for the common good. They manipulate
economies in their own self interest. The worlds central banks have effectively
destroyed the life blood of their host economies and now the global economy with
their Great Money Swindle. And Still, Collectively maintaining their purpose and
p...

A.N.Other - Hyperinflation

|2009-03-28 13:03:58

If the new money will never find its way into the system then why did they
bother printing it? It would seem it's a completely useless thing to do then.

I'm no economist, but new money seems to find a way into the system sooner
or later -- even money currently pledged to prop up a failing system will
ultimately enable banks and other institutions to lend etc etc, which ultimately
is effectively money finding its way into the system and which ultimately must
have inflationary effects, it would seem...

dooby - Bonds

|2009-06-12 16:51:14

you print money, you sell the bonds to back it, the debt is owed no matter what
you do with the money! You could use it as toilet paper, burn it, but taxpayers
will still be liable for its creation.

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