Quantative Easing

Question 1

How does quantitive easing work? (5)

Answer 1

1. Central bank creates new money
2. This money is used to buy assets mainly government bonds
3. More demand leads to higher prices for assets: lead to lower yield on gov bonds
4. Can cause a long term fall in IR
5. This should boost AD through a rise in consumption and investment

Question 2

Why does the liquidity trap effect happen? (2 reasons)

Answer 2

1. Expectations of future IR changes
   • People downgrade forecasts for returns on investments
   • They hoard cash or save in an interest account
2. Credit Crunches
   • When their is a collapse in confidence
   • Lenders cut the amount they are prepared to lend to each other

Question 3

How to overcome a liquidity trap (4)

Answer 3

• Fiscal policy: running a larger budget deficit to boost AD
• Pressure on central banks to supply financial markets with extra liquidity to encourage them to lend to each other
• Rise in inflation can help: real IR negative = spending
• Central bank convincing IR will remain low

Question 4

Bonds

Answer 4

Interest bearing securities that firms and governments can issue to raise capital

Question 5

Bonds explained (4)

Answer 5

• The owner is paid an annual yield
• They can be traded in secondary markets
• The less someone pays the yeild increases
• Formula: % Yeild = (coupon/market price) x 100