In the recent times, Quantitative Easing policy of the US Federal Reserve has gained a lot of attention from businesses, investors and stock markets the world over. This has generated curiosity in the minds of many as to what it actually is and how it affects the world economy. This article is an attempt to satisfy such curious minds.
To understand quantitative easing, let us go through the story of recession in the US, its post effects, and how the economy got back on the path of recovery.
In the year 2008, the US realized the development of recession in its economy, evidenced by the bankruptcy of Lehman Brothers. As the housing bubble burst, borrowers failed to repay loans; banks and financial institutions went bankrupt; investments dropped; unemployment spread and consumption fell. Money supply in the economy reduced dramatically.
Some banks were bailed out to avoid the state of bankruptcy. After having faced huge credit crunch, these banks had become reluctant to lend to new or existing projects, thus furthering recession. The Federal Reserve (the central bank of the US) lowered the bank rates to promote lending at low rates of interest. The bank rate kept reducing and reached near zero, at a level after which it could not be reduced further. But this effort did not bear fruit as the banks and financial institutions were using the funds to invest in risk-free long-term government bonds. The deadlock of money supply worsened. Businesses needed funds, but the banks were not lending any.
At this stage, revival of US economy required the use of some unconventional monetary policy from the Federal Reserve. The Fed opted for Quantitative Easing (QE). This tool was first used by the Bank of Japan in 2001. Quantitative Easing, as the name suggests, eases pressure in the economy by pumping money into the system. How it was carried out is easy to understand. The Fed started purchasing long-term government bonds from the banks and financial institutions in...
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