Quantitative Easing Is Defined As The Expansion Of Central Bank Balance Sheet Essay

Apart from the main function of monetary policy formulation and implementation, Arnold (2008), also gives other functions of the Federal Reserve System which include supplying the economy with paper money (Federal Reserve notes) in addition to serving as the lender of last resort. Being the last means that when other banks, especially the commercial banks, suffer from cash management or liquidity

Due to the 2008 financial crisis, the Bank of England employed quantitative easing (an unconventional monetary policy used to stimulate the economy) by cutting interest rates down to 0.5 % and has been keeping it until now. The Bank made the decision to keep QE and the interest rate unchanged in March. Spare capacity (the ability of a firm to produce more of a product than is now being produced) is used by the BoE to justify its use of forward guidance policy (a communicative tool for monetary policy). Low interest rates improved the economy by increasing consumption and investment, which are the components of AD. The AD curve shows the total spending on goods and services in a period of time at a given price level. In constructing on AD

The Federal Reserve increases its reserves by issuing loans to a commercial banking system. This allows the bank that is borrowing reserves to disburse credits to the public. The Federal Reserve Banks offer primary credit, secondary credit, and seasonal credit, to bank organizations each with its own interest rate. Depending on if the Fed wants to decrease or increase the interest rate can be a positive or negative effect to the public. If the rate is decreases it encourages banking organizations to get more loans. When this is done the banks acquire more funds and are able to disburse more loans the people.

For centuries, banks have relied on fractional reserve banking. This is the method in which only a fraction of a bank’s deposits are actually backed by a reserve of cash-on-hand, available for immediate withdrawal. This procedure allows the bank more capital to lend and at the same time, grows the economy. The reserve amounts are determined by a ratio stipulated by the Federal Reserve. In theory, fractional reserve banking works most of the time. However, in difficult economic times, people have demanded to withdraw

When there are problems in the United States economy, whom do the people turn to? The most obvious answer is the government. The federal government is given the responsibility of maintaining a stable economy. When the economy is not stable, like during a recession, the American people turn the government and demand that they fix whatever problem is occurring. The government can handle the economy in a recessionary period in one of two ways: expansionary fiscal policy or expansionary monetary policy. The sector of the government that handles the economy using these policies in a recession is the Federal Reserve. The best course of action to get the United States out of a recession is to use expansionary monetary policy.

As the onslaught of the sub-prime mortgage crisis began in late 2007, the housing market plummeted sending the economy into what is now known as the Great Recession. The Federal Reserve, as well as the private and government sectors, quickly took notice. In November of 2008 the Federal Reserve undertook its first trimester of quantitative easing; which means the Fed began purchasing treasury securities to increase the money supply in the system, with the hopes that the increase in assets would encourage lending and investment, leading to a resurgence of the economy in terms of unemployment rates and GDP. As time progressed the Fed continued to implement quantitative easing into its third trimester due to a lack of sufficient results.

The United States Federal Reserve has been conducting open market operations in the financial markets since 2008 in order to drive down interest rates and promote economic growth following the 2007-08 financial crisis. The subsequent recession, dubbed the Great Recession, destroyed $19 trillion in household wealth and nearly 9 million jobs. The highly controversial quantitative easing (QE) program, which refers to the process of introducing new money into the money supply, has been effective in promoting US recovery over the past six years.

To stabilize the economy bonds are used which release money into the market. The responsibility of the Central Bank is to maintain the health of the banking system and regulating the purchase and sale of bonds. The interest rates are controlled to balance the markets. According to the Monetary Policy Report to Congress, “The Federal Open Market Committee (FOMC) maintained a target range of 0 to ¼ percent for the federal funds rate throughout the second half of 2009 and early 2010” while representing forecasted economic decisions to rationalize low levels for longer times on the federal funds rate (Federal Reserve, 2010). Purchases were still being made by the Fed’s to result in improvements to the economy through focusing on mortgages, the real estate market, and the credit market. Predictions by the Federal Open Market Committee depicted low levels on the federal funds rates in early 2010 which would continue for some time while over time the economy would see growth, a rise in inflation, and a decline in unemployment. Feds were in agreement though they expected the recovery process to be slower. Purchases by the Federal reserve were slowed, “$300 billion of Treasury securities were completed by October” and “the purchases of $1.25 trillion of MBS and about $175 billion of agency debt” were suppose to be finished the first quarter of 2010 (Federal Reserve, 2010).

One form of direct control can be exercised by adjusting the legal reserve ratio (the proportion of its deposits that a member bank must hold in its reserve account), and as a result, increasing or decreasing the amount of new loans that the commercial banks can make. Because loans give rise to new deposits, the possible money supply is, in this way, expanded or reduced. This policy tool has not been used too much in recent years. The money supply may also be influenced through manipulation of the discount rate, which is the rate if interest charged by the Federal Reserve banks on short-term secured loans to member banks. Since these loans are typically sought to maintain reserves at their required level, an increase in the cost of such loans has an effect similar to that of increasing the reserve requirement. The classic method of indirect control is through open-market operations, first widely used in the 1920s and now used daily to make some adjustment to the market. Federal Reserve bank sales or purchases of securities on the open market tend to reduce or increase the size of commercial bank reserves. When the Federal Reserve sells securities, the purchasers pay for them with checks drawn on their deposits, thereby reducing the reserves of the banks on which the checks are drawn. The three instruments of control explained above have been conceded to be more effective in preventing inflation in times of high economic activity than in bringing about revival from a

When the Federal Open Market Committee (FOMC) wants to increase the money supply, they buy up government bonds from the public on the bonds markets (Mankiw, 2009). The result of buying bonds puts money in the pockets of the public, if the Fed wants to decrease the money supply, they sell off bonds. It is generally thought that when the public has more money available to them, they will consume more. This increased consumption should lead to an overall increase in Gross Domestic Product (GDP) and expansion of the economy.

      Monetary policy is under the control of the Federal Reserve System and is completely discretionary. It is the changes in interest rates and money supply to expand or contract aggregate demand. In a recession, the Fed will lower interest rates and increase the money supply. The Federal Reserve System’s control over the money supply is the key Mechanism of monetary policy. They use 3 monetary policy tools- Reserve Requirements, Discount Rates/Interest Rates, and Open Market Operations. The reserve requirement is the percentage of bank deposits a bank must hold in reserves and cannot loan out. By raising or lowering the reserve requirements, the Fed controls the amount of loanable funds. The interest rate is the amount the FED charges private banks, so they can meet the reserve requirements. The prime rate is currently set at 5%. If the Interest rate is low, the banks will borrow more money from the FED and the money supply will increase. Interest rates have been above average for the past 20 years, but are currently considered low. Open Market Operations is the most effective and most used

Monetary policy, ‘The government’s policy relating to the money supply, bank interest rates, and borrowing’ (Collin: 130), is another tool available to the government to control inflation. Figure 4 shows, that by increasing the interest rate (r), from r1 to r2, the supply of money (ms) is reduced from Q1

The recent recession lasting from 2007 until 2009, and the effects of which are still highly visible in the U.S. economy, led the Federal Reserve to use new and largely untested methods for protecting the country from a total financial collapse. The new strategy, which blurs the lines between monetary and fiscal policy, had been attempted only once before, and is open to criticism from several difference angles. This report documents the history, purpose, and controversy surrounding quantitative easing as a strategy to mitigate the effects of the recent recession. After considering these factors, the conclusion is drawn that quantitative easing was a modestly successful policy, yet one which should not be employed again. Although

This involves buying or selling financial instruments like bonds in exchange of money to be deposited with the central bank. By selling the financial instruments, the central bank mops up the cash in circulation. On the other hand, selling injects money thus increasing the supply of money (Bernanke 2006).

Quantitative easing refers to the practice of pumping money into the economy of a nation so that the banks are encouraged to lend. The government injects money into the economy with the hope that people and companies will be able to sped more. There is a greater chance for an economy to spring back to life when there is increased spending.