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Overview of quantitative easing. Created by Sal Khan.
Video transcript
During normal times in the economy, the Fed tries to control the amount of economic activity that's occuring 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 doesn't 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 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 kind of prime the pump, in order to kind of 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 is 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, 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, ten years out. And the point here would be twofold. One would be 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 the borrowing cost 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 trying 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--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 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.