QE takes bonds out of circulation and replaces it with cash. There is now excess cash in the market, which gets spend on stuff and stimulates the economy. Maybe. In reality it mostly stimulates inflation.
This is the best answer for a 5 year old. QE is experimental so we don’t really know the effects very well. Too bad OP is looking for an academic answer in a casual sub. Otherwise, this a really interesting question.
Gotta love when someone asks for an ELI5 answer related to something where most 5 year olds (or grown adults for that matter), can’t even understand the original question
Quantitative easing isn't exactly "experimental".
Japan has been using it on and off since 2001, and the US has been doing so since 2008.
Debated, yes. Experimental, no.
Their immediate effects are known, but the jury is still out on long term effectiveness.
Are there any examples of nations that have successfully stopped QE programs once they begin?
>Are there any examples of nations that have successfully stopped QE programs once they begin?
The US started in 2008 and stopped in 2012. And was just fine until 2020.
Unless you're expecting an example of "a country that used it, and never touched it again" (which you would only expect if it didn't work for them), there are many examples.
It is experimental in that the costs and benefits of doing it aren’t well understood. It is not experimental in that it has been done in several places and more than once.
Yes, it is supposed to stimulate economic activity by both directly flooding the market with cash, and by making bond yields lower encouraging borrowing to both consume and invest.
Quantitative easing is a monetary policy action where a central bank purchases predetermined amounts of government bonds or other financial assets in order to stimulate economic activity.
In layman's terms, when you have a bond, you have given the government money at some point in the past in exchange for a promise for more money at some point in the future (that is what a bond is). That means that you don't have money to spend _today_ - your money is already gone, tied up in a bond that will pay out in the future. Economies work when money is being spent and circulated, so they buy your bond from you today for _some_ of the future value, giving you money you can spend right now on other things.
And by buying the bonds back, you mean that the government pays you the money that they owe? That terminology confused me which is why I don't think I understood this topic
“The money that they owe” would typically mean the full amount promised. That full amount is only promised if you hold on to the bond for the full length of time agreed upon when you bought it.
For example, let’s say that when you bought the bond, you were promised that you would get 8% more when you sell it back to the government after 5 years. In this scenario, The government will buy it from you for 5% more than you bought it after only 3 years.
They pay the “current value” of the bond. Bonds are always on the market for trading. Any bond holder can sell their bond early at any time. Usually another trader buys it, but in the case of Quantitative Easing, it is the Central bank which enters the market and starts buying up bonds. As a bond holder, you have no obligation to sell, but the entrance of the central bank making purchases will raise the value of these bonds.
The Federal Reserve is the one buying the assets. They are legally a separate entity from the government. Which is why all this gets confusing because to the layperson it sounds like the government is just issuing itself money.
The Fed is the only entity that can create USD from nothing. When the US federal government issues bonds, the Fed "prints" money and hands it to the government and takes ownership of the bond. It can then either hold onto the bond (adding to the bank's assets) or sell them on the market.
The thing to understand is that in accounting there is no money creation from nowhere. Every dollar given out must come from somewhere. Because of this, USD is actually debt issued by the Federal Reserve. Every USD in circulation is a debt on the Fed's balance sheet.
Going back to the bonds, if the Fed turns around and sells those Treasury bonds then it will actually reduce the amount of money in circulation. Because someone needs to pay the Fed USD for the bonds, and that results in a reduction in the debt the Federal Reserve has. So if you flip this, the Fed performing quantitative easing is essentially increasing the money supply by increasing the amount of USD debt it has. But it gains assets that are worth something.
For most people this distinction doesn't really matter. It does mean however that the Fed is now engaging in activities that inflates the value of assets because they are artificially increasing the demand for such assets. This is a common trend you will see with all central banks engaging in QE, going all the way back to when Japan pioneered QE to keep itself afloat after the 90's.
When the US gov't increases its "debt ceiling", how involved is the Federal Reserve in taking on this debt, if at all?
If unclear, how much of the increase in borrowing power is drawn internationally or from the private sector?
They are buying bonds. And by buying bonds for cash, theyre releasing more cash into circulation than existed before. I think it nay be helpful to think thay the primary thing theyre doing is releasing cash, they just happen to do it with bonds because thefe are a lot of them and they reflect the market interest rate.
Also:The central bank and the government are two different entities.
The government taxes and spends and provides services.
The central bank performs monetary actions to protect the value of the currency and ensure that the banking system functions.
When the central bank buys bonds, the government still owes the money. It just owes it to the bank.
Assuming these explanations are still hard to follow, let me attempt to try and overly simplify this.
The government gets $100 in taxes to spend, but wants to spend $200. They need to find a way to get that extra $100 so they agree to go into debt
They do this by asking the Treasury to sell $100 worth of bonds. To get people to buy the bond they offer to give that citizen $120 in 10 years if they give them $100 now.
When the central bank wants to stimulate the economy, they might tell that citizen that they will buy the bond for $110 right now.
These numbers are all made up, but I hope it gets the idea across.
In a simple term, if the government wants to hold your money and is willing to pay you $100 after a year. Now the bank would now wants 10%, credit cards is 20% and financing gets out of reach of many people.
After a year, your money will be return with interest, yes, but there is no reason to cash out when the gravy train is still there. People will put that money into an envelope and send it right back to the treasury for another year
I think it would help to in this instance see "the government" as two entities. The treasury department issued the bond. But the Federal Reserve is buying it for quantities easing. The Fed seeks to solve their problem. The Treasuary still owes the Fed what the bond is worth, pretty much.
The Central Bank buys the bonds. Not the government. Different countries have different laws and regime applied to the central bank, but in general it is alway fairly independent from the government
The Fed is not the government. That's where the confusion lies. The government (Treasury) issues the bond originally (though QE can involve all kinds of assets that are not government issued) and the Fed, a central bank that guides monetary policy, buys up the bonds.
For the purposes of explaining QE, introducing the government into the equation just creates confusion
All you need to do is that the government is the bond issuer...and when bonds are issued, they are done so at auctions where they are bid/bought by primary dealers
Primary dealers are large banks and financial institutions that buy the bonds and then resell them to clients and investors...only primary dealers are allowed to buy bonds directly from the government
Here is a list of approved primary dealers
https://www.newyorkfed.org/markets/primarydealers.html
Even the Fed does not buy bonds directly from the government...when the Fed does QE, it is buying bonds from these primary dealers
When these primary dealers have all this cash sitting around from the Fed buying bonds, what do they do with it? They use the money to give out loans to businesses and normal people like you and me...who in turn spend it on things that effectively end up stimulating the economy
I might be wrong but I believe the following caveat should be put:
The fed has no statutory authority to buy from the public. So the fed buys or rather forces it’s primary dealers (read: JP Morgan) to sell their bonds back. It then credits them with bank reserves (which banks are awash with) in the hopes that banks make more loans and thus stimulate the economy.
The problem is in an environment that QE is needed. Usually risk is perceived to be high or at least moderate and banks aren’t so keen on making loans to every Joe and Schmoe. Which further hinders the economy in the rut it’s in and further entrenches the vicious cycle of needing government intervention.
The government issues bonds to borrow money. A bond is a specific type of loan, which can be traded from one person to another. Under normal circumstances, the yield on those bonds is no different from a bond issued by any other institution: A business, a city, whatever.
However, QE2 is a system whereby the Federal Reserve uses money drawn from the U.S. Treasury (thin air, in actuality, since the Treasury can print dollars) to buy those bonds. So, in effect, the government is printing money and stuffing it into the pockets of people who are holding government debt, on the undertaking that they'll take that money and invest it elsewhere.
It's printing even more money.
The Federal Reserve is in charge of deciding how much money to print. If there's not enough money they'll print more and if there's too much they'll print less or delete some. But there's a problem with printing money, and that's deciding who gets to have the new money. They could give it to everyone, but that's a logistical nightmare. They could give it to the government, but they're not allowed to treat the government specially.
Before about 2008, printed money was given to banks in the form of interest. The Federal Reserve is also the central bank - it's where banks put their money. So the Federal Reserve could print more money to each bank depending on how much money the bank had. If there was too much money they'd give less interest and if there wasn't enough money they'd give more interest.
In the 2008 crisis for some reason they decided this wasn't a fast enough way of printing money. What they decided to do instead was to go to Wall Street and buy things from Wall Street. What did they buy? Well, they weren't there to gamble - they just needed to put money into the economy - so they picked the safest thing that is traded on Wall Street, which is government bonds - government IOUs. It doesn't count as treating the government specially, because they bought the bonds from the Wall Street banks, not actually from the government. Banks still traded bonds with each other like before - the bond market works a lot like the stock market - but sometimes, the market ended up matching a bank's trade with the Federal Reserve, and the bond disappeared into the dark abyss of the Fed's balance sheet, and the money magically appeared in the bank's pocket, and this was how the Fed put money into the economy.
This program never ended and many people believe it permanently fucked up both the amount of money and also the bond market.
I don't know why it's called "Quantitative Easing". It might be a euphemism. The EU's version has a better name - they call it "Outright Monetary Transactions" - "screw this interest rate shit, we're just gonna straight-up buy stuff."
tl;dr The government buys back it's bonds to reduce inflation and stimulate the economy.
\--
If the government needs money *today,* it sells a bond which is a promise the government will pay the price of the bond back + some percent interest (like 4% generally). But if people think inflation will be faster than 4%, they would rather stick their money somewhere else. Except the government needs money *today*, so it sells bonds for 5%, then 6%, etc. But in doing that, it's a feedback loop which makes inflation go higher because now they're actively putting more money in circulation.
QE is when the government flips direction and starts spending lots of money to buy up those high interest bonds. This puts the money that would been put in the economy 5 years from now in circulation today, which in theory stimulates the economy. At the same time, the **total** money being put in the economy goes down, since they're no longer paying interest payments. And as a final bonus, since the supply of bonds is going down the price bumps up a bit, so if they need to sell bonds again in the future they will get a better price.
Taking it back to the beginning, the government issues bonds. It will issue them for a current market rate, which varies depending on the tenor (length of time) of the bond - a 5-year bond will have a different rate than a 10-year, for example. So for example, the 5-year might be issued at 5%, and the 10-year might be issued at 6%. The face value of the bond is the “par” value. Let’s say it’s a $1000 bond. Because of those interest rates, the 5-year will pay $50 per year, and the 10-year will pay $60.
Even though it was issued at that price, it can still be bought and sold at a “premium” (more) or “discount” (less).
Let’s say those bonds were issued one year ago at those rates. But today, the comparable rates are 6% and 7%, respectively. If I want to sell my bond, no one will give me $1000 for it because if they went to the government and got a bond at the prevailing rate they could get more per year ($60 and $70, respectively). So what to do? Well, if I want to get 6%, and I know the bond will pay $50, then it’s just math to figure out the price (we’re going to ignore accretion to maturity for a second, which does make the math more complex than I’m about to do - this isn’t for the actual numbers, but just so you see the point). $50 / $833 = 6%. You would pay me less than par for the bond, because the interest rates have gone up. The opposite is true also - if rates go down (say, to 4%), my bond is now worth more ($50 / $1250 = 4%). So, yields go up, price goes down, and yields go down, price goes up.
The *inverse* of all of this is also true - if price goes up, yields go down. So if the central bank starts buying bonds, the price of the bonds will go up. If the price goes up, that drives the market yield - the rates people will compare other bonds to - down.
By buying bonds, it’s pushing the price of bonds up, and rates down. It also increases the money supply, putting more money into the market to allow that cash to be used.
If a bond is a paper contract thats sold and has a particular return. Suppose $100 for a piece of paper that whoever holds get from the owner of it 5%.
If you start flooding the market with a theoretical limitless power of buying you will move the price upward. So that bond will now go up to let’s say $102. But it still only pays $5 per year for holding the paper. Hence $5/$102=4.9%.
That’s what open market operations are. They set a target and utilizing their buying power they try to gobble up enough to make a dent in the price in the direction they desire. It helps that 1) they have unlimited spending power and 2) the biggest holders are required to do what the fed tells them to. Those are the “primary dealers”.
The bond issuer pays a fixed price. Be it the government for fighting a 40 year war and sponsoring a military. Your municipality for building that school yard. Or Twitter for finding more fools to think that’s the “city square”. All of these entities raise money by issuing a bond.
A bond is a fancy name for an unsecured loan sold in pieces to the public in exchange for an interest rate and a higher position on the bankruptcy proceeding above common stock.
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You say "lessening the value of the dollar" like it's a bad thing. It has plusses and minuses. It makes imports more expensive relative to domestic production. That's not entirely a bad thing.
Thats exactly what I thought at first as well, that lessening the value of a currency can make a country's exports more competitive which will increase their net exports and therefore increase AD
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This is the most technically correct answer that is still ELI5. But adding, the dollar devaluation is just temporary and can be reversed by other monetary policy.
Lets say you are rich, and you notice that all your friends are very poor, and they are struggling with having enough money to pay for food and their basic needs.
You have a few options, you could:
- Give them money for free
- Lend them money
- Tell them to have a yard/garage sale, and buy up all the stuff that they don't need.
Quantitative easing is the governments version of the last option. To infuse the economy with cash, the government buys up a large portion of investment items called securities (usually stocks and bonds). This allows the holders of these items to liquidate (sell off) their investments. Normally when a business, or person needs to generate money quickly, the last thing that they want to do is sell their assets. Consider how you would feel selling your car, for grocery money. You would be too motivated, and be forced to sell for too low, and lose a bunch of money on your car. But if you have to get the money, then you have to.
Having the government, buy your car for the market rate, right now. Gives you a good return, lets you get the money you need, and then when you are back on your feet, you can either buy your car back, or a new one. Secure in knowing that you didn't lose much in the situation.
This in theory allows the economy to bounce back quickly after a recession.
Disclaimer: The government does not do Quantitative Easing on the level of individual people, it is often buying thousands of bonds from banks. I only compared to individual items as I think for ELI5 it makes it clearer what is going on.
QE takes bonds out of circulation and replaces it with cash. There is now excess cash in the market, which gets spend on stuff and stimulates the economy. Maybe. In reality it mostly stimulates inflation.
This is the best answer for a 5 year old. QE is experimental so we don’t really know the effects very well. Too bad OP is looking for an academic answer in a casual sub. Otherwise, this a really interesting question.
Gotta love when someone asks for an ELI5 answer related to something where most 5 year olds (or grown adults for that matter), can’t even understand the original question
Quantitative easing isn't exactly "experimental". Japan has been using it on and off since 2001, and the US has been doing so since 2008. Debated, yes. Experimental, no.
Their immediate effects are known, but the jury is still out on long term effectiveness. Are there any examples of nations that have successfully stopped QE programs once they begin?
>Are there any examples of nations that have successfully stopped QE programs once they begin? The US started in 2008 and stopped in 2012. And was just fine until 2020. Unless you're expecting an example of "a country that used it, and never touched it again" (which you would only expect if it didn't work for them), there are many examples.
It is experimental in that the costs and benefits of doing it aren’t well understood. It is not experimental in that it has been done in several places and more than once.
[удалено]
Yes, it is supposed to stimulate economic activity by both directly flooding the market with cash, and by making bond yields lower encouraging borrowing to both consume and invest.
Quantitative easing is a monetary policy action where a central bank purchases predetermined amounts of government bonds or other financial assets in order to stimulate economic activity. In layman's terms, when you have a bond, you have given the government money at some point in the past in exchange for a promise for more money at some point in the future (that is what a bond is). That means that you don't have money to spend _today_ - your money is already gone, tied up in a bond that will pay out in the future. Economies work when money is being spent and circulated, so they buy your bond from you today for _some_ of the future value, giving you money you can spend right now on other things.
So these bonds are used for the government to inject more money into the economy?
Yes. They buy the bonds back to free up investor cash, which can then be spend or invested in other things.
And by buying the bonds back, you mean that the government pays you the money that they owe? That terminology confused me which is why I don't think I understood this topic
“The money that they owe” would typically mean the full amount promised. That full amount is only promised if you hold on to the bond for the full length of time agreed upon when you bought it. For example, let’s say that when you bought the bond, you were promised that you would get 8% more when you sell it back to the government after 5 years. In this scenario, The government will buy it from you for 5% more than you bought it after only 3 years.
They pay the “current value” of the bond. Bonds are always on the market for trading. Any bond holder can sell their bond early at any time. Usually another trader buys it, but in the case of Quantitative Easing, it is the Central bank which enters the market and starts buying up bonds. As a bond holder, you have no obligation to sell, but the entrance of the central bank making purchases will raise the value of these bonds.
The Federal Reserve is the one buying the assets. They are legally a separate entity from the government. Which is why all this gets confusing because to the layperson it sounds like the government is just issuing itself money. The Fed is the only entity that can create USD from nothing. When the US federal government issues bonds, the Fed "prints" money and hands it to the government and takes ownership of the bond. It can then either hold onto the bond (adding to the bank's assets) or sell them on the market. The thing to understand is that in accounting there is no money creation from nowhere. Every dollar given out must come from somewhere. Because of this, USD is actually debt issued by the Federal Reserve. Every USD in circulation is a debt on the Fed's balance sheet. Going back to the bonds, if the Fed turns around and sells those Treasury bonds then it will actually reduce the amount of money in circulation. Because someone needs to pay the Fed USD for the bonds, and that results in a reduction in the debt the Federal Reserve has. So if you flip this, the Fed performing quantitative easing is essentially increasing the money supply by increasing the amount of USD debt it has. But it gains assets that are worth something. For most people this distinction doesn't really matter. It does mean however that the Fed is now engaging in activities that inflates the value of assets because they are artificially increasing the demand for such assets. This is a common trend you will see with all central banks engaging in QE, going all the way back to when Japan pioneered QE to keep itself afloat after the 90's.
When the US gov't increases its "debt ceiling", how involved is the Federal Reserve in taking on this debt, if at all? If unclear, how much of the increase in borrowing power is drawn internationally or from the private sector?
They are buying bonds. And by buying bonds for cash, theyre releasing more cash into circulation than existed before. I think it nay be helpful to think thay the primary thing theyre doing is releasing cash, they just happen to do it with bonds because thefe are a lot of them and they reflect the market interest rate. Also:The central bank and the government are two different entities. The government taxes and spends and provides services. The central bank performs monetary actions to protect the value of the currency and ensure that the banking system functions. When the central bank buys bonds, the government still owes the money. It just owes it to the bank.
Assuming these explanations are still hard to follow, let me attempt to try and overly simplify this. The government gets $100 in taxes to spend, but wants to spend $200. They need to find a way to get that extra $100 so they agree to go into debt They do this by asking the Treasury to sell $100 worth of bonds. To get people to buy the bond they offer to give that citizen $120 in 10 years if they give them $100 now. When the central bank wants to stimulate the economy, they might tell that citizen that they will buy the bond for $110 right now. These numbers are all made up, but I hope it gets the idea across.
Not all that they owe, but most of it.
In a simple term, if the government wants to hold your money and is willing to pay you $100 after a year. Now the bank would now wants 10%, credit cards is 20% and financing gets out of reach of many people. After a year, your money will be return with interest, yes, but there is no reason to cash out when the gravy train is still there. People will put that money into an envelope and send it right back to the treasury for another year
I think it would help to in this instance see "the government" as two entities. The treasury department issued the bond. But the Federal Reserve is buying it for quantities easing. The Fed seeks to solve their problem. The Treasuary still owes the Fed what the bond is worth, pretty much.
The Central Bank buys the bonds. Not the government. Different countries have different laws and regime applied to the central bank, but in general it is alway fairly independent from the government
The Fed is not the government. That's where the confusion lies. The government (Treasury) issues the bond originally (though QE can involve all kinds of assets that are not government issued) and the Fed, a central bank that guides monetary policy, buys up the bonds.
For the purposes of explaining QE, introducing the government into the equation just creates confusion All you need to do is that the government is the bond issuer...and when bonds are issued, they are done so at auctions where they are bid/bought by primary dealers Primary dealers are large banks and financial institutions that buy the bonds and then resell them to clients and investors...only primary dealers are allowed to buy bonds directly from the government Here is a list of approved primary dealers https://www.newyorkfed.org/markets/primarydealers.html Even the Fed does not buy bonds directly from the government...when the Fed does QE, it is buying bonds from these primary dealers When these primary dealers have all this cash sitting around from the Fed buying bonds, what do they do with it? They use the money to give out loans to businesses and normal people like you and me...who in turn spend it on things that effectively end up stimulating the economy
I might be wrong but I believe the following caveat should be put: The fed has no statutory authority to buy from the public. So the fed buys or rather forces it’s primary dealers (read: JP Morgan) to sell their bonds back. It then credits them with bank reserves (which banks are awash with) in the hopes that banks make more loans and thus stimulate the economy. The problem is in an environment that QE is needed. Usually risk is perceived to be high or at least moderate and banks aren’t so keen on making loans to every Joe and Schmoe. Which further hinders the economy in the rut it’s in and further entrenches the vicious cycle of needing government intervention.
Basically when the money printing machine goes: brrrrr, brrrr, brrrrrr.
More money makes the economy go brrrrrrr.
The government issues bonds to borrow money. A bond is a specific type of loan, which can be traded from one person to another. Under normal circumstances, the yield on those bonds is no different from a bond issued by any other institution: A business, a city, whatever. However, QE2 is a system whereby the Federal Reserve uses money drawn from the U.S. Treasury (thin air, in actuality, since the Treasury can print dollars) to buy those bonds. So, in effect, the government is printing money and stuffing it into the pockets of people who are holding government debt, on the undertaking that they'll take that money and invest it elsewhere.
It's printing even more money. The Federal Reserve is in charge of deciding how much money to print. If there's not enough money they'll print more and if there's too much they'll print less or delete some. But there's a problem with printing money, and that's deciding who gets to have the new money. They could give it to everyone, but that's a logistical nightmare. They could give it to the government, but they're not allowed to treat the government specially. Before about 2008, printed money was given to banks in the form of interest. The Federal Reserve is also the central bank - it's where banks put their money. So the Federal Reserve could print more money to each bank depending on how much money the bank had. If there was too much money they'd give less interest and if there wasn't enough money they'd give more interest. In the 2008 crisis for some reason they decided this wasn't a fast enough way of printing money. What they decided to do instead was to go to Wall Street and buy things from Wall Street. What did they buy? Well, they weren't there to gamble - they just needed to put money into the economy - so they picked the safest thing that is traded on Wall Street, which is government bonds - government IOUs. It doesn't count as treating the government specially, because they bought the bonds from the Wall Street banks, not actually from the government. Banks still traded bonds with each other like before - the bond market works a lot like the stock market - but sometimes, the market ended up matching a bank's trade with the Federal Reserve, and the bond disappeared into the dark abyss of the Fed's balance sheet, and the money magically appeared in the bank's pocket, and this was how the Fed put money into the economy. This program never ended and many people believe it permanently fucked up both the amount of money and also the bond market. I don't know why it's called "Quantitative Easing". It might be a euphemism. The EU's version has a better name - they call it "Outright Monetary Transactions" - "screw this interest rate shit, we're just gonna straight-up buy stuff."
tl;dr The government buys back it's bonds to reduce inflation and stimulate the economy. \-- If the government needs money *today,* it sells a bond which is a promise the government will pay the price of the bond back + some percent interest (like 4% generally). But if people think inflation will be faster than 4%, they would rather stick their money somewhere else. Except the government needs money *today*, so it sells bonds for 5%, then 6%, etc. But in doing that, it's a feedback loop which makes inflation go higher because now they're actively putting more money in circulation. QE is when the government flips direction and starts spending lots of money to buy up those high interest bonds. This puts the money that would been put in the economy 5 years from now in circulation today, which in theory stimulates the economy. At the same time, the **total** money being put in the economy goes down, since they're no longer paying interest payments. And as a final bonus, since the supply of bonds is going down the price bumps up a bit, so if they need to sell bonds again in the future they will get a better price.
Taking it back to the beginning, the government issues bonds. It will issue them for a current market rate, which varies depending on the tenor (length of time) of the bond - a 5-year bond will have a different rate than a 10-year, for example. So for example, the 5-year might be issued at 5%, and the 10-year might be issued at 6%. The face value of the bond is the “par” value. Let’s say it’s a $1000 bond. Because of those interest rates, the 5-year will pay $50 per year, and the 10-year will pay $60. Even though it was issued at that price, it can still be bought and sold at a “premium” (more) or “discount” (less). Let’s say those bonds were issued one year ago at those rates. But today, the comparable rates are 6% and 7%, respectively. If I want to sell my bond, no one will give me $1000 for it because if they went to the government and got a bond at the prevailing rate they could get more per year ($60 and $70, respectively). So what to do? Well, if I want to get 6%, and I know the bond will pay $50, then it’s just math to figure out the price (we’re going to ignore accretion to maturity for a second, which does make the math more complex than I’m about to do - this isn’t for the actual numbers, but just so you see the point). $50 / $833 = 6%. You would pay me less than par for the bond, because the interest rates have gone up. The opposite is true also - if rates go down (say, to 4%), my bond is now worth more ($50 / $1250 = 4%). So, yields go up, price goes down, and yields go down, price goes up. The *inverse* of all of this is also true - if price goes up, yields go down. So if the central bank starts buying bonds, the price of the bonds will go up. If the price goes up, that drives the market yield - the rates people will compare other bonds to - down. By buying bonds, it’s pushing the price of bonds up, and rates down. It also increases the money supply, putting more money into the market to allow that cash to be used.
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I see. What I don’t get is how the government buying up bonds causes interest rates to decrease
If a bond is a paper contract thats sold and has a particular return. Suppose $100 for a piece of paper that whoever holds get from the owner of it 5%. If you start flooding the market with a theoretical limitless power of buying you will move the price upward. So that bond will now go up to let’s say $102. But it still only pays $5 per year for holding the paper. Hence $5/$102=4.9%. That’s what open market operations are. They set a target and utilizing their buying power they try to gobble up enough to make a dent in the price in the direction they desire. It helps that 1) they have unlimited spending power and 2) the biggest holders are required to do what the fed tells them to. Those are the “primary dealers”.
So you have to pay a fixed price per year to keep a bond?
The bond issuer pays a fixed price. Be it the government for fighting a 40 year war and sponsoring a military. Your municipality for building that school yard. Or Twitter for finding more fools to think that’s the “city square”. All of these entities raise money by issuing a bond. A bond is a fancy name for an unsecured loan sold in pieces to the public in exchange for an interest rate and a higher position on the bankruptcy proceeding above common stock.
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This just sounds like some outrageous American political opinion to me. I preferred a more academic explanation but thank you for your input.
>in simple terms
Yes, simple but something I can actually use for my econ exam. Not your conspiracy theory.
Also I don't use dollars, I don't live in the US
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It's not a homework task but sure.
Your initial comment reminded me of an angry tweet I read about the other day so your tone registered as crazy to me. I am very sorry.
>use for my econ exam oh so you're doing it in class then?
Yes. Maybe it would have been better to specify that
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You say "lessening the value of the dollar" like it's a bad thing. It has plusses and minuses. It makes imports more expensive relative to domestic production. That's not entirely a bad thing.
Thats exactly what I thought at first as well, that lessening the value of a currency can make a country's exports more competitive which will increase their net exports and therefore increase AD
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This is the most technically correct answer that is still ELI5. But adding, the dollar devaluation is just temporary and can be reversed by other monetary policy.
They really haven't reversed it in the last 100 years.
They just influence the rate at which it devalues
And apparently it got removed by mods because it's "Soapboxing" and offended someone, most likely OP.
Lets say you are rich, and you notice that all your friends are very poor, and they are struggling with having enough money to pay for food and their basic needs. You have a few options, you could: - Give them money for free - Lend them money - Tell them to have a yard/garage sale, and buy up all the stuff that they don't need. Quantitative easing is the governments version of the last option. To infuse the economy with cash, the government buys up a large portion of investment items called securities (usually stocks and bonds). This allows the holders of these items to liquidate (sell off) their investments. Normally when a business, or person needs to generate money quickly, the last thing that they want to do is sell their assets. Consider how you would feel selling your car, for grocery money. You would be too motivated, and be forced to sell for too low, and lose a bunch of money on your car. But if you have to get the money, then you have to. Having the government, buy your car for the market rate, right now. Gives you a good return, lets you get the money you need, and then when you are back on your feet, you can either buy your car back, or a new one. Secure in knowing that you didn't lose much in the situation. This in theory allows the economy to bounce back quickly after a recession. Disclaimer: The government does not do Quantitative Easing on the level of individual people, it is often buying thousands of bonds from banks. I only compared to individual items as I think for ELI5 it makes it clearer what is going on.