3. (4 points) Quantitative easing is the central bank\'s open market purchases o
ID: 1115780 • Letter: 3
Question
3. (4 points) Quantitative easing is the central bank's open market purchases of long-term government bonds. a. Use the AD-AS model to demonstrate the effect of quantitative easing when the policy is a temporary policy. Explain both short-run and long-run effects of the b. Display the short-run and long-run Phillips curves that are consistent with your c. Use the AD-AS model to demonstrate the effect of quantitative easing when the policy on inflation and output. answer in Part (a). Explain your reasoning. policy is a permanent policy. Explain both short-run and long-run effects of the policy. d. Display the short-run and long-run Phillips curves that are consistent with your answer in Part (c). Explain your reasoning.Explanation / Answer
Ans..
Quantitative easing (QE) is an unconventional form of monetary policy where a Central Bank creates new money electronically to buy financial assets, like government bonds. This process aims to directly increase private sector spending in the economy and return inflation to target.
AD & AS Curve
Quantitative easing is a policy pursued by the Federal Reserve Board 2008 to 2014. The Fed has been purchasing financial assets, MBSs, bonds, etc., from banks and other private financial institutions. The Fed has implemented this policy in three steps:
QE1: November 2008 to June 2010. The Fed purchased $1,800 billion of mortgage-backed securities (MBSs), Treasury bonds, etc.
QE2: November 2010 to June 2011. The Fed purchased an additional $600 billion.
QE3: September 2012 to October 2014. The Fed authorized the purchase of up to $40 billion of mortgage-backed securities (MBSs) and Treasury bonds per month.
In total the Fed purchased a total of $4.5 trillion of financial assets. First we explain the rationale behind this policy. Then we will use the bank’s balance sheet to explain the nuts and bolts of the policy.
Rationale behind Quantitative Easing
Philipps Curve:
The curve suggested that changes in the level of unemployment have a direct and predictable effect on the level of price inflation. The accepted explanation during the 1960’s was that a fiscal stimulus, and increase in AD, would trigger the following sequence of responses:
An increase in the demand for labour as government spending generates growth.
The pool of unemployed will fall.
Firms must compete for fewer workers by raising nominal wages.
Workers have greater bargaining power to seek out increases in nominal wages.
Wage costs will rise.
Faced with rising wage costs, firms pass on these cost increases in higher prices.
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