By S. Wade Hansen, analyst at LearningMarkets.com
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.]
As you will see in the video, 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
Video Lesson: Understanding How Quantitative Easing Works
I've scratched the surface of this topic in the article above, but I go into much more detail about what quantitative easing is and how it is implemented in the Understanding Quantitative Easing Video. Click here to watch.
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