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Then work on Problems and Applications 4.10, at the end of Chapter 28, answering and discussing...

Then work on Problems and Applications 4.10, at the end of Chapter 28, answering and discussing the questions in that exercise.

4.10

[Related to the Making the Connection on page 957] In an opinion column in the Wall Street Journal, Martin Feldstein of Harvard University argued with respect to quantitative easing that, “low interest rates are generating excessive risk-taking by banks and other financial investors.” He also warned that the risks could have serious negative effects on the value of pension funds.

a. What is quantitative easing?

b. Why might quantitative easing have led investors, banks, and pension funds to engage in excessive risk taking?

c. Why might this risk reduce the value of pension funds?

Source: Martin Feldstein, “The Fed Should Start to Taper Now,” Wall Street Journal, July 1, 2013.

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Ans.

A) Quantitative easing is an monetary policy where central bank purchase government securities from market to lower interest rate and increase money supply or ease liquidity conditions in an economy . The central bank create money to buy bonds from financial institutions which reduces interest rates. Such that businesses and people borrow more to spend more.

B) Quantitative easing have led investors, banks, and pension funds to engage in excessive risk taking because lower interest rates for longer time period will lead to excessive risks. These risks have adverse effects on bank capitals.That is efficacy of quantitative easing is low where costs and risks are substantial.

C) This risk might reduce value of pension funds because lower interest rates due to quantitative easing has forced pension funds to put money in low yielding government bonds. As bond yields falls the pension funds must invest more capital in bonds to generate enough income to pay its members But due to reduced yield in bonds it can lead to acquire low yielding assets. Such that value of pension funds reduces.

Rahul Sunny answered 2 years ago
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