Illustrate the effect of Fed’s substantial trading in the MBS market during QE.

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Expert Solution

Quantitative easing is used to stimulate an economy by making it easier for businesses to borrow money.The Fed buys mortgage-backed securities (MBS) and U.S. Treasurys from its member banks which increases liquidity in the flow of money in capital markets. The Fed issues a credit to the banks' reserves as it buys MBS from them, this results in increased liquidity due to higher money supply in the system. For example, recently on March 15, 2020 Fed announced that It would purchase $500 billion in U.S. Treasurys and $200 billion in MBS over the next several months.

Pumping in so much new money into the financial system also causes interest rates to drop. This low interest rate is also expected to simulate demand as people and businesses can borrow money at lower cost.

Another effect of this will be that the value of dollar will remain low (due to large supply of new dollars), this will make the stocks of the US companies appear cheaper than before and thus more attractive to foreign investors, thus it is also expected to encourage foreign investors to invest more and stay invested in US listed comapnies.

jeff jeffy answered 1 year ago

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