Understanding Quantitative Easing

Rohit Basbanand Dhoundiyal

Once upon a time.....

`Lets say there was a

prosperous village, where villagers are into agriculture. The village has schools, shops, entertainment, hospitals etc.

One day, a well respected pundit arrived in the village.

The villagers believed the pundit was blessed with the ability to

predict the future.

Meeting was held in the village and the pundit

predicted that the villagers would lose their job & source

of livelihood.

The villagers began to save their money like there was

no tomorrow.

Shops were deserted. The demand for all the goods and services dropped and resulted in

drop in prices.

There was economic instability.

Fall in demand led to closing of shops which led

to shortage of goods.

People also started losing their jobs.

By sensing the problem, Govt. Officials made an

announcement.

Key points of the announcement

Money would be available at 0% interest.

No upper limit for the borrowing.

Pay their debts on future date.

Quantitative Easing

A process of increasing the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity and stop credit crunch situation.

The fund is created electronically not physically.

Circular flow of money

FirmsFinancial

Institutions/BanksIndividuals

Savings/Investments

Loans

Loans

Savings

Income

Factors of production

Goods/Services

Revenue

Methods

Interest Rate

Open market operations(OMO)

Effects of Quantitative Easing

Inflation

Standard of living

Depreciation of currency

Investment in assets

History of QE

Bank of Japan in early 2000’s

US Federal Reserve from 2008-13

European Central Bank in 2009

Bank of England in 2009–10

Questions?

Why electronic funds rather than physical funds?

Concept of Yield & Price?