Quantitative Easing for Dummies


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FACTBOX: What is quantitative easing?

Tue Dec 16, 2008 3:30pm EST

NEW YORK (Reuters) – The Federal Reserve on Tuesday cut its target for overnight interest rates to zero to 0.25 percent, bringing it closer to unconventional action to lift the economy out of a year-long recession.

“The message is they’re instituting quantitative easing on a fairly large scale,” said Doug Roberts, chief investment strategist at Channel Capital Research.com.

Under quantitative easing, central banks flood the banking system with masses of money to promote lending.

Central banks exchange non or low interest bearing assets- reserve balances- for longer term higher yielding securities.

Since lending is in no case ‘reserve constrained’, the ‘extra’ reserves do nothing for lending.

The purchase of the longer dated securities results in lower longer term rates than otherwise. The lower borrowing rates may or may not alter aggregate demand.

The lower rates for savers definitely lowers aggregate demand.

They usually do this when lowering official interest rates no longer is effective because they already are at or near zero.

True!

The central banks add cash by buying up large quantities of securities — government debt, mortgages, commercial loans, even stocks — from banks’ balance sheets,

Yes.

giving them plenty of new money to lend.

No, they already and always have infinite ‘money to lend’.

Available funds are not a constraint for the banking system.

The constraints are regulated asset quality and capital requirements that are expressed in the rates bank charge.

Not the total quantity of funds available.

It is a tool used by Japan earlier this decade to combat deflation and stimulate the economy.

Didn’t work then either. It was fiscal policy that kept them afloat, though not a large enough deficit to sustain output at full employment levels.


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