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Quantitative Easing (QE) and How the Fed Responds to Financial Crises - YouTube
Channel: TD Ameritrade
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In March 2020, the Federal Reserve, or Fed,
cut its target interest rate to zero in response
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to the economic slowdown caused by the Covid-19
pandemic.
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This led some to wonder if the Fed was all
out of ammo钮 in its attempt to spark economic
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growth.
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But when faced with an economic crisis, the
Fed has many tools at its disposal to boost
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economic activity and keep the money flowing.
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One of those tools is called quantitative
easing, or Q-E.
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QE is a tool used by central banks to provide
liquidity and keep money moving through the
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economy.
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In the United States, the Fed has typically
done this by purchasing securities like longer-term
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Treasuries and mortgaged-backed securities
on the open market.
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The intent is to keep rates lower and help
lenders find investors.
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So how is QE different from the Fed's usual
tools?
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The Fed is charged with managing the U.S.
monetary policy, which means changing the
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money supply in an attempt to manage economic
growth and inflation.
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The Fed typically does this using the federal
funds rate, which is a very short-term interest
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rate that helps determine borrowing costs
for banks.
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The Fed sets a lower target for the short-term
rates through a process called open market
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operations.
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It essentially creates or quote-unquote prints
money by buying very short-term Treasuries,
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which pushes the rate lower.
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Normally, that lower short-term rate can lower
interest rates across the board.
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This makes borrowing for people and businesses
cheaper, ideally boosting the economy.
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But during a financial crisis, economic worries
may hamper the trading and lending that lowers
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the longer-term rates.
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When this happens, the Fed may engage in QE.
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It does this by buying other assets like longer-term
Treasuries, mortgage-backed securities, or
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commercial debt.
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Buying these assets can pull the yield lower
in targeted areas.
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The goal is to find places where money isn't
flowing and remove the logjam.
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The Fed used several rounds of QE to help
the economy recover from the financial crisis
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of 2008, buying billions in Treasuries and
mortgage-backed securities between 2008 and
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2014.
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In response to the Covid-19 crisis in 2020,
the Fed again instituted QE.
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This time it announced essentially unlimited
QE, assuring investors it would continue to
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help the economy as long as it was needed.
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The Fed also expanded the program to include
buying corporate bonds and bond funds.
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In addition to QE, the Fed also responded
to the coronavirus by reinstating 2008 crisis
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measures like lending programs for banks,
large corporations, and foreign central banks.
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It also loosened some financial regulations
introduced after the 2008 financial crisis
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and introduced new lending programs for small-
and medium-size businesses and state and local
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governments.
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So, the Fed is clearly not out of ammo
when it cuts the federal funds rate to zero.
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However, printing all this money may come
at a cost.
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The U.S. dollar, like any asset, can fall
in value if there's an enormous increase
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in supply.
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Some economists fear that QE could result
in hyperinflation, or a fast rise in the costs
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of goods and services.
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Since the 2000s, broad inflation has been
kept in check by free trade, globalization,
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and higher productivity, which lowered the
costs of many goods and raw materials.
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However, prices of assets like stocks, bonds,
and housing have seen tremendous inflation.
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Additionally, purchases that often require
loans such as college, housing, and cars have
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seen a dramatic rise in prices.
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While there are numerous factors that can
impact the prices of goods and services, some
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economists point to Fed policies as a cause.
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Along with inflation, some economists have
argued that the increased money supply and
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the low cost of borrowing could result in
a debt trap, where servicing the rising
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debt levels may make it harder for businesses
and individuals to spend and invest in ways
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that lead to economic growth.
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Finally, other economists argue that inflated
asset prices caused by QE primarily benefit
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the wealthy rather than supporting broader
economic growth driven by middle-class consumption.
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Even if its long-term impacts remain unclear,
QE can have shorter-term impacts on your portfolio.
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If QE is successful, then the economy could
grow, and stock prices would rise.
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But the picture is different for bond investors.
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Generally, bond prices tend to rise when interest
rates go down or when the Fed initiates QE.
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But if the federal funds rate is at zero,
it may be hard for bond prices to go higher,
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although some countries have experimented
with negative interest rates.
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In response to rates going to zero, investors
may instead seek yield by investing in corporate
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bonds and dividend-paying stocks.
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But both of these moves mean potentially taking
on more risk.
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In addition, if inflation does occur, precious
metals have historically been a hedge against
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inflation.
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Some investors may turn to gold and silver
commodities and stocks for potential growth.
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QE is meant to help the economy grow, but
it's no guarantee.
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So, investors should have a plan for how they'll
respond to the potential effects of QE.
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smarter.
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