FRM Part II · FRM Exam Part II · Monetary and Fiscal Policy: Safeguarding Stability and Trust
A central bank buys long-dated government bonds from the market and pays for them by creating bank reserves, with the stated aim of lowering long-term yields once its policy rate is near the effective lower bound. Which description best fits this policy?
This is quantitative easing. The central bank buys long-dated bonds with newly created reserves, which lowers the term premium and prompts portfolio rebalancing, reducing long-term yields when the policy rate cannot fall further. Selling long bonds would do the opposite.
- AQuantitative easing, operating mainly through a lower term premium and portfolio rebalancingCorrect
- BYield curve steepening achieved by selling long-dated bonds and buying short-dated bills
- CFiscal consolidation financed by raising tax rates on bondholders
- DA currency peg defended by selling foreign reserves
Explanation
Large-scale purchases of long-dated bonds funded by new reserves are quantitative easing. They lower long-term yields by compressing the term premium and pushing investors to rebalance into other assets. Selling long bonds would raise long yields, so the second option is the opposite of the described policy.
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