Another quantitative easing video
About this video
Facing a recession, the Fed first lowers the federal funds rate by printing money and buying short-term treasuries. Once that rate is about 0%, buying short-term debt won't help, so it buys other assets such as longer-term treasuries, mortgage-backed securities or commercial debt: quantitative easing. Bernanke calls his version credit easing because its aim is to fix logjams in particular credit markets.
You'll be able to
- explain how the Fed lowers the federal funds rate in a recession.
- explain why buying short-term debt stops working when the rate is about 0%.
- describe quantitative easing and Bernanke's idea of credit easing.
Key words
- recession
- A period when the economy shrinks and activity slows.
- federal funds rate
- The rate at which banks lend reserves to each other overnight.
- quantitative easing
- Printing money to buy assets beyond short-term debt, to get money into circulation and affect other markets.
- credit easing
- Bernanke's name for printing money to buy particular assets where credit markets are jammed.
Transcript
Let's say the United States economy is going into a recession or maybe even worse than a recession. And you are the Chairman of the Federal Reserve and you need to do something about it. Well, the first thing you would do is that you would lower the federal funds rate.
And that's the rate that banks lend to each other overnight. And the way that you lower it, if the banks don't do it on their own after you say you want to lower it, is that you print money as the Federal Reserve. And you use it to buy usually short-term treasury securities.
And then that money gets deposited in banks. So the demand for reserves, because that's what these things are, the demand for reserves goes down, supply goes up, and the federal funds rate should go down. But what happens if you keep doing this and you keep lowering the federal funds rate all the way down so that the overnight borrowing rate is approximately 0%?
What do you do then if the economy still looks like it's in a bit of a tailspin? Well you could still print money, but using that money to buy short-term debt won't help any because you're not going to lower the short-term overnight interbank interest rate anymore.
So you can go out and buy other things. And those other things can be longer term treasuries or it could be other types of securities. You could buy mortgage-backed securities. You could buy commercial debt. And this idea of printing money, not just for target interest rate, but essentially, to get that money into circulation and maybe to affect other parts of the market, this is called quantitative easing.
And in Bernanke's mind, although that's exactly what he's doing, he's printing money to buy other things than what the Fed traditionally does when he cares about the overnight borrowing rate, he calls it, not necessary quantitative easing, but credit easing. And in his mind, even though mechanically they are the same thing, in his mind, he saying, look, I'm printing this money not just for the sake of printing the money and putting it into circulation, I'm printing money so that I can buy particular assets where it seems like there might be a log jam in the credit markets.
Because with just printing money and buying government securities, maybe the interest rates on government debt goes down, but maybe because of panic or crisis, interest or the prices on these things don't behave properly. So in order to fix that, credit easing, in the Bernanke sense, would be to go out and buy this type of asset.
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