The Federal Reserve–“The Fed”, “The Lender of Last Resort,” is the central banking system of the United States. There are twelve regional Federal Reserve Banks across the country that house additional cash of private banks through its “federal funds” function. It serves multiple purposes that include overseeing monetary policy, balancing the roles of the government and privatized banking, bailing out institutions that are too big or crucial to fail (as seen in the 2008 Financial Crisis), and holding reserves for private banks for when there is a severe and widespread withdrawal of funds during economic turmoil.
One of the tools the Fed uses for its monetary policy regulation is the supervision of open market operations, a job done by the FOMC (Federal Open Market Committee). With open market operations the Fed can determine how much cash is available for private banks to loan to the public. It does this by buying or selling US Government Bonds. When the Federal Reserve buys these bonds from private banks, they exchange cash for the bonds and inject money into the American economy. When the Federal Reserve sell these bonds to private banks, they exchange these bonds for cash and contracts the American economy’s money supply. This is called Quantitative Easing, a common phrase you may have heard on the news (or in a children’s novel). The Fed does this to maintain a steady money supply, to avoid inflation, and keep interest rates low.
When the American economy is moving slowly, The Fed expands the money supply by buying bonds to make more money available to the public for investment. Here, the Federal Reserve is encouraging Americans to invest or spend. When the American economy is growing robustly, The Fed contracts the money supply by selling bonds to decrease the cash available to the public for investment. Here, the Federal Reserve is encouraging Americans to save their money, and invest or spend less to avoid inflation.
QE is critical for the protection of low interest rates. High interest rates are unattractive because they make loans or mortgages more expensive. Higher interest rates are enforced when there is too much spending in an attempt to curb spending and avoid inflation. QE is used in times of a slow economy with minimal spending and lots of saving. The economy grows when people invest and spend, so interest rates are pushed down to spur this growth.
So, when you hear, “The Fed has begun a new round of quantitative easing,” understand that your investment is urged. When investment is urged, the public is on the spot because they ultimately determine if the market becomes bearish or bullish (cautious vs. confident). At such times, you will determine if you are generally a bear or a bull–whether you’re generally pessimistic or optimistic.
Quantitative easing has become a popular tool for governments around the world in the aftermath of the financial crisis. The Federal Reserve’s President, Ben “Brah” Bernanke, is applauded for successfully mitigating the effects of the Crisis due to his effective quantitative easing strategy. He ensured the stability of the American financial system by spurring spending after the initial fear and shock subsided from the markets. Initially, here was no way to discourage people from divesting their cash from banks because the crisis was gigantic and losses were large and real. However, the recession could have prolonged much further if Bernanke did not masterfully utilize quantitative easing.
Next time you’re stressing about something, just quantitatively take it easy.