What exactly is Quantitative Easing?

It is when the Federal Reserve or any central bank tries to increase money supply (stimulate the economy) by buying financial assets. In this case we are talking about U.S. Treasuries and Agencies. This buying pushes interest rates down.

How Does the Fed Traditionally Push Interest Rates Down?

They typically have two avenues:

1)   Adjusting the Federal Funds rate lower. Note: we are currently at zero so there is no lower they can go. Everybody loves a good game of Limbo!

2)   Buying bonds and other financial assets to make those prices go higher and yields go lower.

Option number 2 is Quantitative Easing.

What Does This Mean for Bonds?

If the market expects Quantitative Easing to begin and/or continue, bond prices will rise.

Why Do We Need Rates Lower?

The Fed will raise rates when they are fearful of fast rising prices in an economy- called inflation. They will lower rates when they are fearful of fast falling prices in an economy- deflation.

I Like Lower Prices- Why Doesn’t the Fed Mind It’s Own Business

You do not like lower prices. It means the economy is on unstable ground. This could lead to falling home prices and rising unemployment. If corporations cannot charge enough money for their goods, they can’t hire you to produce them.

So the Fed has Two Jobs: Balancing Inflation & Deflation and Keeping Jobs

Correct. And this is referred to as it’s “dual mandate”.

Related Articles: Here is a article from the Wall Street Journal on Quantitative Easing and Deflation and Quantitative Easing Explained: In Talking Cartoons.

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