In terms of the mechanics of quantitative easing,
A. quantitative easing formally changes interest rates; open-market operations only influence rates.
B. it works the same as open-market operations.
C. it differs from open-market operations in that the securities purchases occur directly from households.
D. it only changes the interest rate; it doesn’t influence bank reserves.
The correct answer and explanation is:
Correct Answer: B. It works the same as open-market operations.
Explanation:
Quantitative easing (QE) and open-market operations (OMO) share similarities in their basic mechanics. Both involve the central bank purchasing government securities or other financial assets to influence the money supply and stimulate the economy. However, quantitative easing is a broader, more aggressive application of the same principle.
Understanding Open-Market Operations:
Open-market operations are the routine tools central banks use to regulate the short-term money supply and maintain their target interest rates. The central bank buys or sells government securities from commercial banks and other financial institutions to either inject liquidity into the financial system (expansionary policy) or reduce it (contractionary policy). These operations primarily target short-term interest rates, such as the federal funds rate in the U.S.
What is Quantitative Easing?
Quantitative easing is essentially an extension of open-market operations, but it is employed when traditional monetary policy tools, such as cutting short-term interest rates, are insufficient—often because rates are already near zero (a situation called the “zero lower bound”). QE is used to stimulate the economy in times of severe economic downturn or deflationary risks.
In QE, central banks purchase longer-term securities, such as government bonds, corporate bonds, or mortgage-backed securities, to directly inject liquidity into the economy and encourage lending and investment. This differs slightly from routine OMO, which typically targets short-term securities.
Similarities in Mechanics:
Both QE and OMO involve the purchase of securities, which increases the reserves of commercial banks. This expansion of reserves allows banks to extend more loans, increasing the money supply. Additionally, both aim to reduce interest rates—though QE specifically targets longer-term rates.
In summary, QE operates on the same principles as OMO but is larger in scale and scope, with a focus on boosting economic activity during extraordinary times.