However a special problem with the 2008 global economic crisis was that interest rates in areas like the US and Europe were close to 0%. Unable to reduce short-term rates further, the Federal Reserve has resorted to unconventional monetary policy to reduce long term interest rates. The Fed achieves this by declaring that it will keep short-term rates low, which helps lower bond yields. And it also buys bonds on the open market which further lowers bond yields.
For example, with Quantitative Easing, the Fed credits its own account (the digital equivalent of printing money) and then uses that money to purchase government bonds on the open market from financial firms such as banks and insurance companies. This procedure increases the price of the bonds which makes them a less attractive investment. The money that firms make from the bond sales can then be invested in other companies or lent to individuals, usually at a lower interest rate to attract borrowers.
Once the US economy is in good shape, the Fed will tighten (decrease) the money supply to prevent high inflation. It will do this by selling the originally purchased bonds and then debiting its account (thus destroying the money it originally created).
This is a nice, succinct summary of what the US is trying to accomplish with QE.
ReplyDeleteOne problem seems to be that QE lowers the value of all currency in circulation while benefiting those at the receiving end of the investments from the firms making money from the bond sales. Low interest rates, on the other hand, are generally more accessible to anyone (though they favour those who are risk-seeking enough to take loans, start businesses etc). Ideally the firms would invest the money evenly, but more practically it seems that they favour investments in markets (driving up the price of stocks,etc) so that those who have sufficient capital to be in those markets benefit while those without gain nothing (except the hope of economic recovery). So for the cost of a general devaluation of the currency, a power law applies (those with much receive more).
I agree about the power law, but it seems to me to be a feature, not a bug. Here's my thinking:
Delete1. The main beneficiary of QE is the government since the Fed printed the money. The benefit to firms/borrowers is really a spillover effect (though, of course, an intended one).
2. It is the most promising firms and borrowers at the margin that will receive money. That is, those that have the best profit/risk profiles.
3. Those same firms and borrowers would be expected to receive money in normal times.
I may be missing what you were getting at with "Ideally the firms would invest the money evenly". But I would expect ideal investments to be efficient, not even.