9. Quantitative Easing and Open Market Operations

“The single currency area’s recovery remains exposed to global risks, despite a large-scale quantitative easing package in which the region’s central bankers have spent €1.4tn on bonds and cut rates deep into negative territory.”

 

I was reading the two letters QE in the Financial Times, all the time and I were never sure what they actually mean.

I figured out that QE is quantitative easing or open market operations. Probably also not going to ring a bell. QE is done in crisis or during bad economic times to stir up the economy. It means that the Central Bank is pumping money into the system to support it. How does that work?

They literally print money in their basement and buy treasury bills with it. How does that look like? The central bank buys treasury bills from me, therefore I have more money to finance my party. Additionally, they buy treasury bills from banks or dealers to provide liquidity for the economy. Using this liquidity/money, banks can make investments or give loans to people to buy houses or cars which fire up the economy.

Normally the CBs were only buying treasuries bills but in the financial crisis, the EU crisis and during the announcement if the Brexit the CBs were suddenly buying other securities like mortgage-backed securities (house loans) or bonds from companies.

Another positive effect of having more liquidity in the market is that we have lower interest rates as well. The more liquidity/money we have, the lower the interest rates and vice a visa.

If there are big quantities of anything in the market whether we are talking about money or normal goods, it gets cheaper. So if there is a lot of money in the market, borrowing money becomes relatively cheap.

As you see in this picture that looks more like a piece of modern art than a balance sheet, you actually see the balance sheet of the Fed from the 07/03/08. The balance sheet consisted mainly of treasury bills as assets. During the financial crisis, the Fed suddenly bought MBS (red), which are mortgage-backed securities and Maiden Lane (loans from companies) and other assets (turquoise) to rescue the banks.

The black line which represents the monetary basis grew from 500,000$ Millions to 2,000,000$ Million, because the American CB printed all that money to buy treasury bills, MBS and other assets to rescue banks and the economy. That is quantitative easing at its finest.

Especially in the financial crisis, the banks gave away too many loans to people that could not pay them back. During QE the Central banks print money and use this money to buy these loans. The banks have new money to operate and the central bank has these loans on its balance sheet.

What is quantitative easing?

The central bank can obviously also sells securities to take money out of the system. They sell the loan back to the bank and receive money for it. From now on there is less money in the system.

This buying and selling of securities are open market operations to influence the economy.

 

Financial Times Quote: The quote is about the European Central bank printing money to buy company bonds to stabilize the European economy. Even though they have bought all these bonds and fluted the market with money to cut interest rate, the European market is still not doing too good and is strongly influences by the  developments in Britain or America. 

Introduction

The first article: The hierarchy of money

The second article: Why do we need banks?

The third article: Why we need a central bank?

The fourth article: How can banks create money out of thin air?

The fifth article: Why do we need central banks especially in a crisis?

The sixth article: What are clearing houses?

The seventh article: What are Fed Funds?

The eighth article: What are dealers, brokers and repos?

 

The tenth article: Eurodollars

The eleventh article: Discounts, Discounts, Discounts

The twelfth article:  Why dealers provide liquidity

Written by: Philine Paschen

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