Question

What were the Fed’s goals in implementing Quantitative Easing ( QE ) and Operation Twist ? What are the short and long term consequences of these monetary programs ?

Answer 1

Answer:-

Quantitative easing (QE)

QE is nothing but a massive expansion of operation in the open market of a central bank.

Like we can say bank buys securities from its member banks to add liquidity to capital markets. This will have the same effect as increasing the money supply.

However, In the world history the most successful QE effort was undertaken by the U.S. Federal Reserve. Due to which , its balance sheet gone more than quadrupled, from $2.825 trillion in 2008 to $4.482 trillion in 2014.

Fed explained it as flowing the money in to the market for public operation by making credit to the banks' reserve accounts in exchange for MBS and Treasuries.

For example Japan was the first to use Quantitative Easing, from 2001 to 2006

Short term consequences

The objective behind this move is to reduce interest rates allow banks to make cheap loans in the short run. Due to lower rate it has stimulated demand by giving businesses cheap loans for their expansion, and customers more credit to buy things with.

It helped in maintaining the short term liquidity in the market to make them stable for the long run.

It has made its export relatively cheaper.

By increasing the money supply, QE keeps the value of the country's currency low. This makes the country's stocks seem like a relatively good investment to foreign investors, and makes its exports relatively cheaper.

Long term consequences

The objective behind this move of expansionary monetary policy is to reduce interest rates and boost economic growth.

In the long run by increasing the money supply, Fed wants QE to keep the value of the country's currency low, which makes the country's stocks at low cost and make them relatively good investment to foreign investors.

As per Fed (QE) stimulate the economy in another way. The Federal government auctions off large quantities of Treasuries to pay for expansionary fiscal policy.

Fed Treasuries are the basis for all long-term interest rates, which also helped to keep auto, furniture and other consumer debt rates affordable and control the inflation in the market. It also kept long-term, fixed-interest mortgage rates low.

Operation Twist

Fed conducted a new program under the name of “Operation Twist” in late 2011 and 2012 and its objective is to help stimulate the economy.

Under the Operation Twist program Fed’s initiates the buying of longer-term Treasuries and simultaneously selling some of the shorter-dated issues which they already held to bring down long-term interest rates. They named it as Twist as they want to twist the shape of Yield curve.

Short term consequences

In the short run Fed want to quickly control the unemployment rate and inflation until it fell to 6.5% and inflation which rose to 2.5%.

This is the step after QE so they want to further cut the rate in the short run to stimulate more purchasing power to the customers and corporate to finance projects.

Long term consequences

Fed expected that yield on the longer term bonds will fell but this will happen near to the announcement of this policy which means they have achieved their objective in the short term itself.

And if we see the views of finance community on Operation Twist, It was seen to be too weak to improve the economy or bring down the unemployment rate.

It seems the biggest effect of Operation Twist is to make an eventual Fed exit more difficult