Written Assignment 2: Quantitative Easing

Karen Donoso
The article “Quantitative Easing Is Ending. Here’s What It Did, in Charts.” published by the
New York Times, talks about quantitative easing and the effect that it had on the great recession
at the time.
First of all, quantitative easing is a conventional form of monetary policy which is used by the
central bank to encourage the economy of a country when the traditional form of monetary
policy becomes unproductive. The central bank does this by buying financial assets from
commercial banks as well as other private institutions, which leads to creating money and
introduce a determined amount of money into the economy. This has the same effect as
increasing money supply. On one hand, quantitative easing is good for the economy because
lowering interest rates allows banks to make more loans which encourages investment. Also, it
keeps the currency’s value low which makes the country’s stock more attractive to foreign
investors as well as makes exports cheaper. On the other hand, QE increases the excess reserves
of the banks and raises the prices of the financial assets bought, which reduces return. In
addition, if used for too long it could lead to inflation.
The difference between quantitative easing and the traditional monetary policy is that QE is a
more conventional type of monetary policy. This is because, it is under the same principle it
increases the amount of money in the system however it cannot lower the interest rates any more
as they are close 0%. Therefore, as the only factor being eased is the quantity of money,
quantitative easing got created.

The FED used quantitative easing to try and get the economy out of the great recession in the
US. This was due to many variables such as bank’s new financial instrument such as collaterized
debt obligation. CDO consisted of a mixture of good and bad mortgages which were sold to
investors. This was a good idea however, since it was a new idea in the financial market, credit
rating agencies were unable to do an in-depth research so they ended up giving a high rated mark
to CDO’s that had too high-risk mortgage. Mortgage companies went bankrupt followed by
insurance companies as well as banks. The Feds had to intervene by increasing money supply
and since it’s a variable of the money market (M/P), an increase in M would lead to a shift (to
the right) in the supply curve. It then leads to a decrease in the interest rate so money demand
would also increase, which leads to a boost in the economy. In addition, since the money market
is linked to the ISLM curve, when there was a shift in the money supply, it also affected the LM
curve which also shifted to the right (an increase in the LM curve). This not only shows that the
interest rate lowered but also how the GDP of the country increases (Y).
However, the economy can only boost to a certain point, which is why the government brought
in the idea of a more conventional monetary policy QE. As explained above it is almost the same
as the tradidtional monetary policy however due to the lowering of the interest rates and them
being so near to 0, there needed to be able to get bigger amounts of money in an easier way. This
was able to reduce long term yields which increased the efficiency of the traditional monetary
policy.

Some economists believed that quantitative easing would cause inflation in the economy. This
however was not true. This is because, in a recession people are reluctant to waste their money
since they don’t know for how long the economy will be like that, which basically means that
there’s no increase in monetary base. In addition, as mentioned many times before, quantitative
easing doesn’t increase money supply and therefore cannot cause inflation. In this case the
traditional monetary policy caused the inflation in the economy at the time, however the
economy at the time was so bad that it was actually in a deflationary state. This leaves us with
the inflation caused by the traditional monetary policy to actually be a good thing, at least at that
time, to get out of the great recession they were in. In other words, QE could eventually be a
factor of inflation in the economy on the very long run however it doesn’t directly cause it. Also,
many economists believed that it was going to cause hyperinflation which would send them in a
way of a great depression however due to everything mentioned before, it did not cause
hyperinflation due to the state of the economy as well as other variables that stabilized the
economy (brought the economy to an equilibrium) such as the later on increase in money
demand due to the low interest rates.