The U.S. uses Quantitative Easing to boost economic growth in facing a recession, e.g. 2008 Financial Crisis or the current Covid-19. They apply assets purchasing, include such as treasury and MBS (mostly long-term financial high credit assets), to pour a huge amount of money into the financial market, aiming to boost the demand (aggregate demand) and avoid delation that people hoard money for safety.
We would not consider why the U.S. purchases long-term assets because interest rates either in the long or short term would all go down by non-arbitrage conditions. (P.S. long term T-bond rate was even lower than the short term T-bill rate in the first and second quarter of 2021, the unusual situation would largely during to the inefficient market and incontinence of the long term U.S. economy, but most likely the non-arbitrage would be applied later. So, investment opportunities were to short the long term T-bond, as it was overvalued by QE, and it would be back to a relatively lower price than during that time)
Theoritically
Theoretically, there is an increasing supply of money in the loanable fund market by asset purchasing (QE), because CB would buy bonds and lend money. So, the supply of loanable funds increases (the supply curve moves to the right,), and result in a decrease in interest rate. Then, investment increases due to the low cost of using money (low-interest rate).
Then in the AD-AS market, an increase in investment to drive the AD curve moves to the right as well. Considering now the AS curve is upward sloping in the short run, the movement of the AD curve would indeed increase output, Y, (as the U.S. wants) and also increase the price level. As a result, the price level would increase and inflation appears! With continuous QE, even hyper-inflation would happen!
In addition, the U.S. also conducts helicopter drops that directly give money to individuals to boost consumption (that is another problem and I would discuss in the later blog post)
Facts
However, this is not the case in the real world that QE does not create inflation.
One assumption that inflation does not occur is that the economy would be highly deflated if there is no fiscal or monetary policy. The inflation from QE is just offset by the deflation from the “Crisis”.
Whether this assumption is true or not seems unable to be proved. Potential the current heating “Causality” study could help to show that.
Ideas
Some of my thinking and also perhaps further study are the following.
- Inflation is absorbed by the dominant position of the U.S. dollar and “oil-dollar connection”. The inflation is transferred to other countries such as emerging markets or U.S. debt holders such as China. Further study and data are needed there.
- How Marginal Propensity of Consume (MPC) is affected or determined?
8 November 2021
FZ
Monetary Policy
Why does monetary policy work?
$$ \uparrow M \Rightarrow \downarrow i \Rightarrow \uparrow C \uparrow I \Rightarrow \uparrow Y \uparrow Price$$
The monetary market would directly affect the loanable fund market. An increase in the money supply would result in an increase in the money supply, and thus a decrease in interest rate. Later, a lower cost of borrowing and investing would raise the aggregate demand. Therefore, GDP increase.
In addition, with the low-interest rate in the domestic country, the exchange rate goes lower, the domestic currency depreciates relative to the foreign currency. Exports become more competitive.
Through the above two ways, the expansionary monetary policy would decrease unemployment and increase outputs.