Quantitative Easing

Quantitative Easing

The United State’s economic troubles, which strongly persist today in 2012, stem from issues dating back to the late 1990s. About a decade and a half ago, a broad credit bubble had appeared in Europe and in the United States on top of a sustained housing bubble, which had been plaguing the US. These bubbles caused housing prices to rise. When combined with the fact that the primary mortgage market was very poorly regulated, one can see the trouble that ensued: vast amounts of non-traditional mortgages were issued that were deceptive, ambiguous, and often too much for the borrower to repay.

However, the crisis is due to more than just these bubbles and bogus mortgages. Failing credit ratings and securitization caused bad mortgages to convert to toxic financial assets. Managers of middle and large sized financial companies collected extremely large amounts of correlated housing risk, and in turn magnified this risk by using short-term debt to finance it. When the housing bubble collapsed, a great number of firms failed. Some failed due to common shock, while others failed because of risk of contagion (this is when the failures of one firm lead to failures in other areas of other firms). After ten firms, mergers, and restructurings failed in succession, confidence in the economy disappeared, causing the economy to retract severely. Then, in 2009, in an attempt to revive the economy, the Obama administration and the US Federal Reserve announced the beginning of something called Quantitative Easing.

What is QE & Why is it used?

Central banks use quantitative easing as a monetary tool to stimulate and strengthen the economy. When the economy is suffering from a recession or going through tough times, the central bank will often resort to lowering short-term interest rates to boost consumption and lending. The central bank will eventually hit their “zero bound,” the point where interest rates cannot be cut anymore because they are...