Question

A7. At the heart of the inflation versus deflation argument is the massive stimulus that the U.S. Federal Reserve has injected into the economy by way of near zero percent interest rates and quantitative easing.

a. Do the Fed actions support the argument for inflation or for deflation? Explain.

b. What is the difference between lowering interest rates and quantitative easing?

Answer 1

a. FED actions support the argument for deflation . zero percent interest rate  is a route taken by a central bank to keep the base rate at zero per cent in an attempt to stimulate demand in the economy by making the supply of money cheaper. Quantitative easing is an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply.Low rate or zero rate of interest induces households to save less and spend on consumption more . Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity . hence increasing money supply in economy and checking deflation.

B Quantitative easing is a tool available to the reserve bank in order to carry out monetary policy. Normally lowering the interest rate charged to commercial banks is sufficient to lower interest rates generally, increase the money supply and thus stimulate the economy, but at times when there is a real danger of deflation the reserve bank has to use something stronger.The reserve bank does indeed “create money” by purchasing its securities and increasing money supply.