Question

Right now, the Federal Reserve is pursuing a policy of quantitative easing for the third time in the last four years. This means introducing of billion dollars into the economy in an effort to stimulate investment within private sector. Describe the mechanisms the Fed uses to do this , and explain why think this would or would not be effective at stimulating investment.

Answer 1

Quantitative easing refers to the monetary policy whereby a central bank buys government bonds or other financial assets for the purpose of injecting money into the economy to expand economic activity. It is usually used when inflation is very low or negative, and standard expansionary monetary policy has become ineffective.

The Fed implements quantitative easing by buying financial assets from commercial banks and other financial institutions, thus raising the prices of those financial assets and lowering their yield, while simultaneously increasing the money supply. This increases the excess reserves that banks hold. The goal of this policy is to ease financial conditions, increase market liquidity, and facilitate an expansion of private bank lending.

This would not be effective in stimulating investment because-

1) Incase central banks increase the money supply, it can create inflation. The worst possible scenario for a central bank is that its quantitative easing strategy may cause inflation without the intended economic growth.

2) It can devalue the domestic currency. On one hand, a devalued currency can help domestic manufacturers because exported goods are cheaper in the global market, a falling currency value makes imports more expensive. This can increase the cost of production and consumer price levels.

Incase of any doubt, please comment below. I would be happy to help.
Show your appreciation by upvoting the answer if it was of help to you.