QE works through the central banks purchase of financial assets, such as government bonds, corporate bonds, or mortgage-backed securities, from banks or other financial institutions.
By purchasing these assets, central banks inject new money into the economy and increase the reserves held by banks. This, in turn, reduces the cost of borrowing and encourages banks to lend more money to consumers and businesses. The increased lending and lower interest rates can then stimulate economic activity and boost growth.
The effects of QE can vary depending on the specific economic circumstances and the structure of the financial system.
In some cases, QE can lead to increased inflation if the new money supply is not absorbed by productive investments or if consumers and businesses spend more in response to lower interest rates. However, in times of economic recession or low inflation, QE can help to boost demand and stimulate growth.
Here’s a funny video with Jerome Powell, the current Fed chair, printing money.
As we’ve mentioned, QE is considered a unconventional monetary policy tool and has been used as a last resort by central banks when traditional monetary policy tools don’t work.
In the 2008 recession, the Fed could not stimulate the economy through interest rate cuts because the rates were already very low. The Fed offered three rounds of QE, referred to as QE1, QE2, and QE3.
The first round of QE began in November 2008 and involved the Fed purchasing $600 billion worth of mortgage-backed securities and other financial assets from banks and other financial institutions.
The second round of QE began in November 2010 and involved the Fed purchasing $600 billion worth of Treasury bonds.
The third round of QE began in September 2012 and involved the Fed purchasing $85 billion worth of Treasury bonds and mortgage-backed securities each month. This program continued until October 2014, by which time the Fed had purchased over $3.5 trillion worth of financial assets.
The Fed began to taper off QE, and much like what we recently saw in the media, there were a lot of people nervous about the Fed ending the QE program. We’ll talk about the ‘taper tantrum’ in our next post.
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