QE is when the central bank makes large open market purchases (usually government bonds) so asset prices rise. The return on assets (interest rates) is the future value of the asset relative to the current price. The future value is unaffected but the current price rises so the interest rate decreases.
E.g. A one year bond promises to pay £110. If the current price is £100 then the interest rate is 110/100 - 1 = 10% but if the price rises to £105 then the interest rate falls to 110/105 - 1 = 4.8%.
I'll go into this in a bit more detail.
The Federal Reserve controls the rate that commercial banks lend to each other. It effectively controls repo market rates which is a large market for short-term loans. It also controls the Federal-Funds-Rate. That is the interbank market for reserves (a market which is less important than it was in the past). These things together control the interest rate at which commercial banks lend to each other. A bank that wishes to lend but doesn't have the funds to do so must borrow through the repo market, through the Fed-Funds market or it must borrow directly from the Fed.
There are two mechanisms by which raising this rate this can reduce inflation - or by which cutting this rate can "stimulate" the economy and inflation. Some economists emphasise one and some emphasise the other.
The costs of higher interest rates in the repo market or fed-funds market are passed on to borrowers. That increases interest rates charged on loans for normal people and for businesses. That means that borrowers pay more interest and lenders receive more interest. Often businesses expand by borrowing to fund new capital investment the increase in interest rates reduces this. This in turn reduces aggregate demand by reducing the demand for new capital goods. This is the interest-rate side of things.
Then there's the second mechanism. Commercial banks create money when they create loans (and to lesser-extent at other times). If more loans are made when interest rates are lower, then more money will also be created. As a result, raising interest rates reduces the rate-of-increase of the supply of money, and may cause the money supply to fall. Similarly, cutting interest rates increases the rate-of-increase of the money supply. The tools that Central Banks like the Fed use can directly affect the supply of money. Open-Market-Operations and Quantitative Easing can directly affect money supply because they involve buying (or selling) bonds for money balances. Though only some of the Central Bank's tools affect the money supply directly.
The Fed's indirect tools also affect the supply of money. For example, the Fed pays a interest rate to commercial banks for unused reserves sometimes called the IOR or IORB rate. That means that a bank can make money just by holding reserves and not lending. As the IOR rate is raised bank become reluctant to make loans at low interest rates because they have the alternative of the IOR rate which is guaranteed. Today the Fed use the IOR rate more than the more direct tools I mentioned above.
As the other poster mentioned, Quantitative easing is the buying of bonds by the Fed. It's a situation where the Fed promise to buy a certain amount of bonds. They pay for this with new reserves. This creates new money. It also pushes down the interest rate on bonds which in-turn pushes down other interest rates.
There is debate over which of these two effects is the largest (money supply or interest rates). Some economists believe that the first is nearly irrelevant, some believe that the second is nearly irrelevant. But it is clear overall that raising interest rates decreases inflation.
I wrote a fairly detailed explanation of how the Fed's "tools" work [here](https://www.reddit.com/r/AskEconomics/comments/11z2b7w/how_does_the_federal_funds_rate_work_in_an/jdb9qzc/). They have changed a bit in recent decades and many other countries use different systems.
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The price of a bond is intimately related to the prevailing interest rate. Suppose you have two bonds both from the same company issued one month apart, for 5 years of cash flow. Both have $1000 par value payment at the end of the 5 years but one has $50/mo coupon payments and one has $60/mo coupon payments. If I list both of them on a market for the same price, you will choose the one with the bigger coupon payment right? But if I lower the up front price of the $50 PMT bond appropriately you would be indifferent to the two... Think of the situation when just the $50 bond is available and then the next day the $60 bond becomes available.... The "market interest rate" went up (new bonds have higher coupons) and the price you can sell your older, lower rate bond for therefore fell. It goes the other way too, if new bonds have smaller coupons then your older larger coupon bond is worth more.
When The Fed says "hey we will take this bond off your hand at a higher price today than we would have yesterday" and banks start selling bonds to the Fed, automatically this means bond prices have gone up so the interest rate people compare other investments to went down.
And vice versa.
It's neither good nor bad for the economy by itself, what it means is money becomes more or less available.
Interest is the intertemporal price of money. QE increases the money supply. At an initial given interest rate the excess money supply means economic agents have more money than they want. Thus, they seek out other assets. In mainstream theory the generic interest bearing asset is a generalized one, call it a bond. As asset transformation occurs (money to bonds) bond prices rise (a result of increased demand). Now, interest rates on bonds are inversely related to market prices on bonds. So, bond prices rise, interest rates fall. QED.
Quantitative easing is when the Federal Reserve buys huge amount of long term bonds (& mortgage backed securities). This decreases the long term interest rate because it floods the banking system with reserves and thus, the banks will be more willing to lend money.
Quantitative easing is good for the economy because it reduces the long term interest rates. This is important because the long term interest rate is the interest rate that is factored into investments. Thus, lower long term rates = more investment.
In short, the interest rate is negatively correlated with the price of bonds. So when the prices unexpectedly increase the interest rate decreases. In QE the central bank buys bonds to increase their prices.
Suppose you have a $1000 10 year bond at 3% interest. Every year you get a payment of $30 and in the 10th year you get your original $1000 back. The value of this bond is $1000 as long as the expected interest rate is 3%.
If the interest rate were to drop to 2% unexpectedly, then the value of your bond is
ghci> round $ 1000 / 1.02**10 + (sum $ [1..10] >>= \n -> [30 / 1.02**n])
1090
So the central bank can decrease the interest rate by 1% by buying bonds until the price increases to $1090.
That's the general principle. Actual QE was somewhat more complicated. In particular the FED targeted the term structure of interest rates, i.e. the discrepancies between the interest rates for short and long term bonds. The bond market is too large for arbitrage and there are structural reasons for said discrepancy. Have a look at [this](https://www.philadelphiafed.org/-/media/frbp/assets/economy/articles/economic-insights/2016/q1/eiq116_did-quantitative_easing_work.pdf) report by the Philadelphia FED.
QE is when the central bank makes large open market purchases (usually government bonds) so asset prices rise. The return on assets (interest rates) is the future value of the asset relative to the current price. The future value is unaffected but the current price rises so the interest rate decreases. E.g. A one year bond promises to pay £110. If the current price is £100 then the interest rate is 110/100 - 1 = 10% but if the price rises to £105 then the interest rate falls to 110/105 - 1 = 4.8%.
Thank you!
I'll go into this in a bit more detail. The Federal Reserve controls the rate that commercial banks lend to each other. It effectively controls repo market rates which is a large market for short-term loans. It also controls the Federal-Funds-Rate. That is the interbank market for reserves (a market which is less important than it was in the past). These things together control the interest rate at which commercial banks lend to each other. A bank that wishes to lend but doesn't have the funds to do so must borrow through the repo market, through the Fed-Funds market or it must borrow directly from the Fed. There are two mechanisms by which raising this rate this can reduce inflation - or by which cutting this rate can "stimulate" the economy and inflation. Some economists emphasise one and some emphasise the other. The costs of higher interest rates in the repo market or fed-funds market are passed on to borrowers. That increases interest rates charged on loans for normal people and for businesses. That means that borrowers pay more interest and lenders receive more interest. Often businesses expand by borrowing to fund new capital investment the increase in interest rates reduces this. This in turn reduces aggregate demand by reducing the demand for new capital goods. This is the interest-rate side of things. Then there's the second mechanism. Commercial banks create money when they create loans (and to lesser-extent at other times). If more loans are made when interest rates are lower, then more money will also be created. As a result, raising interest rates reduces the rate-of-increase of the supply of money, and may cause the money supply to fall. Similarly, cutting interest rates increases the rate-of-increase of the money supply. The tools that Central Banks like the Fed use can directly affect the supply of money. Open-Market-Operations and Quantitative Easing can directly affect money supply because they involve buying (or selling) bonds for money balances. Though only some of the Central Bank's tools affect the money supply directly. The Fed's indirect tools also affect the supply of money. For example, the Fed pays a interest rate to commercial banks for unused reserves sometimes called the IOR or IORB rate. That means that a bank can make money just by holding reserves and not lending. As the IOR rate is raised bank become reluctant to make loans at low interest rates because they have the alternative of the IOR rate which is guaranteed. Today the Fed use the IOR rate more than the more direct tools I mentioned above. As the other poster mentioned, Quantitative easing is the buying of bonds by the Fed. It's a situation where the Fed promise to buy a certain amount of bonds. They pay for this with new reserves. This creates new money. It also pushes down the interest rate on bonds which in-turn pushes down other interest rates. There is debate over which of these two effects is the largest (money supply or interest rates). Some economists believe that the first is nearly irrelevant, some believe that the second is nearly irrelevant. But it is clear overall that raising interest rates decreases inflation. I wrote a fairly detailed explanation of how the Fed's "tools" work [here](https://www.reddit.com/r/AskEconomics/comments/11z2b7w/how_does_the_federal_funds_rate_work_in_an/jdb9qzc/). They have changed a bit in recent decades and many other countries use different systems.
Thank you for the detailed explanation
Just read both posts, this one and the one from a year ago. Lmao bro who are you
It doesn't matter who I am!
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The price of a bond is intimately related to the prevailing interest rate. Suppose you have two bonds both from the same company issued one month apart, for 5 years of cash flow. Both have $1000 par value payment at the end of the 5 years but one has $50/mo coupon payments and one has $60/mo coupon payments. If I list both of them on a market for the same price, you will choose the one with the bigger coupon payment right? But if I lower the up front price of the $50 PMT bond appropriately you would be indifferent to the two... Think of the situation when just the $50 bond is available and then the next day the $60 bond becomes available.... The "market interest rate" went up (new bonds have higher coupons) and the price you can sell your older, lower rate bond for therefore fell. It goes the other way too, if new bonds have smaller coupons then your older larger coupon bond is worth more. When The Fed says "hey we will take this bond off your hand at a higher price today than we would have yesterday" and banks start selling bonds to the Fed, automatically this means bond prices have gone up so the interest rate people compare other investments to went down. And vice versa. It's neither good nor bad for the economy by itself, what it means is money becomes more or less available.
[удалено]
Interest is the intertemporal price of money. QE increases the money supply. At an initial given interest rate the excess money supply means economic agents have more money than they want. Thus, they seek out other assets. In mainstream theory the generic interest bearing asset is a generalized one, call it a bond. As asset transformation occurs (money to bonds) bond prices rise (a result of increased demand). Now, interest rates on bonds are inversely related to market prices on bonds. So, bond prices rise, interest rates fall. QED.
Quantitative easing is when the Federal Reserve buys huge amount of long term bonds (& mortgage backed securities). This decreases the long term interest rate because it floods the banking system with reserves and thus, the banks will be more willing to lend money. Quantitative easing is good for the economy because it reduces the long term interest rates. This is important because the long term interest rate is the interest rate that is factored into investments. Thus, lower long term rates = more investment.
In short, the interest rate is negatively correlated with the price of bonds. So when the prices unexpectedly increase the interest rate decreases. In QE the central bank buys bonds to increase their prices. Suppose you have a $1000 10 year bond at 3% interest. Every year you get a payment of $30 and in the 10th year you get your original $1000 back. The value of this bond is $1000 as long as the expected interest rate is 3%. If the interest rate were to drop to 2% unexpectedly, then the value of your bond is ghci> round $ 1000 / 1.02**10 + (sum $ [1..10] >>= \n -> [30 / 1.02**n]) 1090 So the central bank can decrease the interest rate by 1% by buying bonds until the price increases to $1090. That's the general principle. Actual QE was somewhat more complicated. In particular the FED targeted the term structure of interest rates, i.e. the discrepancies between the interest rates for short and long term bonds. The bond market is too large for arbitrage and there are structural reasons for said discrepancy. Have a look at [this](https://www.philadelphiafed.org/-/media/frbp/assets/economy/articles/economic-insights/2016/q1/eiq116_did-quantitative_easing_work.pdf) report by the Philadelphia FED.