Question

Outline the ways in which FED easing affects the yield curve. Is it possible for an increase in the real money supply (FED easing) to actually have exactly the opposite effect? Explain the basis of why this is or isn’t possible.

Answer 1

The unconventional monetary policy or quantitative easing used to reduce the longer term interest rates because the FED already control the short term interest rates. This will leads to the increasing purchase of government securities by the central bank to lower interest rate and increase the money supply. This increased money supply will increase the lending rates and liquidity. Quantitative easing used to confront the short term interest rate to zero. This lowering interest rate in long run will enhance the economic development and growth. Fed used several stages in quantitative easing. This will increase the purchase of government securities with price rise and lowering yields.
If the short term interest rates are low, the yield curve become upwards sloping. Both the long term and short term interest rates are connected. If the short term interest rates fall down, the expected short term interest rate will reduce, this will also reduce the long term interest rates. On the other hand, when short term interest rates are low, the interest rates are expected to be high in the future; this will cause the rise in long term interest rates. The easing policy will increase the money supply and this will leads to the high level development and growth of the economy. Purchasing large quantity of the securities will affect the long term interest rates. This causes the long term development also.
The dynamics behind this is, through printing money by the central bank leads to the rise in purchase of bonds by central bank, thus the demand for bond increases and the price of bond rises. This will leads to the fall in interest rate. Thus the people and businessman start to borrow more. The jobs will create, this will boost the economy.