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Quantitative easing

Overview of quantitative easing. Created by Sal Khan.

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  • blobby green style avatar for user GoNavy31
    By buying longer-term treasury bonds, would that not decrease the supply and therefore increase the price? Or is the Fed's buy-back of the bonds actually an increase in supply because the government sells the bonds? I didn't quite understand the way Sal explained the Fed's control of the entire yield curve.
    (4 votes)
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  • blobby green style avatar for user Rick Fischer
    By easing, the Fed gains assets that pay them real dollars, at no cost to themselves. They have a strong incentive to do this, even if it is not the best for the US economy. Too much easing in the 90s and 00s helped create the bubbles, yet paid the Fed handsomely. All done in secret. So, can anyone argue against auditing Fed operations?
    (5 votes)
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  • starky ultimate style avatar for user Sudhanshu Sisodiya
    Why would the Fed want to buy mortgage-backed securities? That just seems so dodgy to me.
    (2 votes)
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  • female robot grace style avatar for user trovial
    Sal mentions in this video and last that the mechanism is
    fed injects money in the system -> banks have more supply -> banks lower prices.
    But i think it is also implied in this video that by buying treasury securities, fed is also increasing demand on those securities thus lowering interests.
    am i correct?
    (1 vote)
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    • blobby green style avatar for user John
      The study of demand and supply comes from the discipline of economics. In economics, we would refer to what you're discussing as the difference between "shifting" a supply or demand schedule, and simply "moving along it". When the Fed purchases securities in the open market, or in accordance with the QE strategies, they are shifting the supply curve. This means that they are changing the entire market's supply schedule at every point in the curve which graphs the relationship between yields and supply of bonds. This quantitiative easing is NOT, however, shifting the demand curve. Buying securities will shift the supply curve, which will cause a new market equilibrium to be formed at a different level of supply and demand. But the demand schedule itself isn't changed. It's hard to discuss this without graphs, but here's a basic rundown of factors affecting supply curves, versus demand curves.

      Supply Curves are affected by:
      -the amount of a given type of good available in the market.

      Demand curves are affected by:
      -People's perceptions about the market
      -People's moral beliefs about products.
      -People's beliefs about what type of securities their stock/bond portfolio should hold
      -The relative prices of securities with identical yields, in economics we call these "substitutes"
      -People's savings (i.e. the amount of funds they have available to invest).

      The distinction is, in a sentence as follows: If it impacts the number of goods, it has to do with supply. If it impacts people's perceptions of goods, markets, or what they should be buying, it impacts demands.

      Thus, quantitative easing shifts the supply curve, because it is simply changing the number of T-bonds, (or what have you) in the marketplace.
      (5 votes)
  • leaf green style avatar for user Myles Cullen
    How does the ECB lower interest rates, Do they buy bonds from various countries or is there an other way they do it?
    (2 votes)
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    • leaf green style avatar for user Ryan
      Depends on what rates we're talking about.

      A central bank completely controls the shortest term interest rates (like the overnight rate). When a central bank changes this rate they don't actually have to do anything. They just announce what the rate will be and the market will move to where the central bank says the interest rate will be. Why? Because the central bank has an unlimited amount of money and no one will stand in their way. If they had to they could buy enough bonds to force the market where they want it to go, but the market participants know this, so they just get out of the way.

      For longer term interest rates, the ECB can do as you said (buy bonds from various countries). If they felt the 10 year rate on Italian bonds was too high, they'd buy Italian 10 year bonds. Or, they could do exactly what they do for short term rates. If the ECB announced that Spain's 30 year bond would yield 1%, tomorrow Spain's 30 year bond would yield 1% because no one would stand in the way of their unlimited balance sheet. This would be similar to when a country pegs it's currency to a certain exchange rate. They would be pegging the interest rate at a certain level. No central bank in any developed country has yet to do this, as far as I know.
      (1 vote)
  • blobby green style avatar for user MCCCXXXI MCCCXXXI
    Why does buying long term debts decreases the interest rate in the long term?
    (1 vote)
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  • aqualine tree style avatar for user meenakshig097
    How does the Fed "buy treasury securities?" What does that mean and how does that lead to an increase in the money supply? I understand quantitative easing, just not how the Fed does it.
    (1 vote)
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  • leaf green style avatar for user Brian McCall
    What are the ramifications to the Stock and Bond Market with the Fed currently buying all the new Treasury debt?
    (1 vote)
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    • leaf green style avatar for user Ryan
      First of all, the Fed does not buy all treasury debt, nor does it buy new treasury debt. You can find online what percentage of outstanding treasuries are held by the Fed. The Fed also only ever transacts on the secondary market, meaning the debt they buy is not new. It has already been auctioned to a willing buyer.

      Proving what ramifications the Fed's actions have had is a very difficult thing to do. Buying a treasury removes that bond from the market, so clearly the Fed has an impact on the treasury market. Removing the treasury would increase demand, which would lower interest rates. But you can't blame all falling interest rates on the Fed when interest rates have been falling for nearly 30 years. Also, the Fed already exerts an incredible amount of influence on the entire treasury curve, from 3 month bills to 30 year bonds. The correlation between 30 year bonds and changes in the Fed funds rate is around 80%. So, proving they have even more influence than they have traditionally always had is also very difficult.

      If it's difficult to prove the extent of which the Fed impacts the treasury market, it's going to be pretty much impossible to prove an impact on other markets.
      (2 votes)
  • leafers ultimate style avatar for user Daniel Wong
    At , He says that buying Mortgage Backed Securities makes the mortgage market a bit looser. What does this mean? And how does this happen? How does injecting money into the economy affect the economy and how?
    (1 vote)
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  • leaf green style avatar for user Pharunyu Phuengkanthai
    What are the benefits of having lower yield curve for long-term bonds/securities? I understand that if the Fed Fund Rate is lower, the cost of financing for businesses is lower, hence more productivity.

    However,
    1) with lower yield, aren't those long-term investments less attractive? If they are so then, doesn't it mean that there will be less capital financing these investments, resulting in lower production?

    2) and how does 'mortgage market (MBS) become a little bit looser, a little bit more liquid'? And how is it beneficial to the economy?
    (1 vote)
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Video transcript

During normal times in the economy, the Fed tries to control the amount of economic activity that's occurring by targeting the federal funds rate. The fed funds rate. And this is the rate that you always hear talked about on the news. And it's essentially a target rate that the Fed wants to see banks lending money-- lending cash to each other-- on an overnight basis. And we saw already in the last video, if the Fed does not like the rate that they're borrowing to each other, and if even announcing the federal funds rate does not cause the banks to say, hey, the Fed's going to intervene if we don't lend to each other at that rate, the Fed can actually intervene. It can go out there, perform open market operations, and buy, usually treasury securities, out from just the general market. And what that does is it increases the amount of cash that is in circulation, which decreases the demand for cash, increases the supply, and it should lower the interest rate. And the Fed usually cares about getting that interest rate within a certain zone, around a certain target. And the treasuries that the Fed normally buys are short-term treasuries. And this is just because this is less risky, and sometimes they'll even make it on a temporary agreement. They'll say, look, we'll buy it from you now, only if you agree to purchase it at some future date at a certain price. And that's called a repurchase agreement. I'll do a whole other video on that. But the whole point of open market operations is to set this overnight borrowing rate. But they usually deal with the short-term treasury debt because it's safer. It exposes the Fed to less interest rate risk. But you can imagine what happens if the Fed keeps lowering interest rates in order to prime the pump, in order to try to stimulate the economy. So it keeps lowering the federal funds rate from 4%, down to 3%, down to 2%, maybe going all the way down eventually to 0%. And the whole time, it's been doing that by printing money and buying short-term US securities. And maybe at this point, the yield curve looks like that. But maybe that's not enough. Maybe the economy's still tanking. Maybe people aren't getting mortgage loans still. So now, the Fed can no longer do its traditional open market operations. And it will no longer be focused on just the federal funds rate, because really, it can't go any lower. It already hit zero. Short-term overnight borrowing between banks is already zero. But if the Fed wants to inject more cash, it can now buy different types of securities. It can buy treasury securities that are-- so instead of short term treasury securities, maybe it could be longer term treasury securities. So maybe stuff that's one year out, five years out, 10 years out. And the point here would be two-fold. One, to inject cash into the system, to print cash and put it out there so it's there for people to invest and for the banking system to operate. But it might be to explicitly control the yield curve further out so that borrowing costs for longer debt goes down, so that the yield curve looks something like that. Because if it's buying longer maturity treasuries that will lower the yield. Or they might even start to buy things that aren't treasuries. Maybe they'll buy mortgage-backed securities. So it makes the mortgage market a little bit looser, a little bit more liquid. And this non-traditional type of intervention, where the Fed is no longer concerned about a target rate, because the target rate is already at zero. Where the Fed is not purchasing short-term debt, but is starting to buy longer term debt, things further down the yield curve. And maybe things that aren't treasury securities to begin with. Maybe they're starting to buy corporate debt. Maybe they're starting to buy mortgage-backed securities. This is called quantitative easing. And there's two elements to it that make it different from traditional Fed open market operations. They are now no longer concerned about the Fed fund rate, because it's already at zero. The other thing is, is that they're buying things maybe further down the yield curve. So they're trying to control the yield curve itself. And they're maybe buying less traditional securities, with the goal of maybe making those markets a little bit more operational.