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Finance and capital markets
Course: Finance and capital markets > Unit 8
Lesson 2: Quantitative easingQuantitative easing
Overview of quantitative easing. Created by Sal Khan.
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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)
Increasing the price of a bond means decreasing the interest rate. That's what the Fed is trying to do when it buys bonds.(3 votes)
- 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)
- "By easing, the Fed gains assets that pay them real dollars, at no cost to themselves". Doesn't Fed pay for the assets they buy?(3 votes)
Why would the Fed want to buy mortgage-backed securities? That just seems so dodgy to me.(2 votes)- They didn't want to, but they felt they had to, in order to prop up the short-term value of those securities, which in turn propped up the short-term solvency of banks and other financial institutions.(4 votes)
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)- 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)
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)- 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)
- Why does buying long term debts decreases the interest rate in the long term?(1 vote)
There is a larger supply of money in the long-term debt market, so that decreases the price of long term debt, which is the interest rate.(2 votes)
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)- They use cash to pay for bonds that are sold to them by banks. The banks bought the bonds from the public for cash, so now the public has cash and the fed has bonds.(2 votes)
- What are the ramifications to the Stock and Bond Market with the Fed currently buying all the new Treasury debt?(1 vote)
- 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)
At3:17, 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)- 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)
3:17Video 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.