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IAI Actuarial Core Principles · Business Economics · Recent macroeconomic history

Following the 2008 crisis, central banks in advanced economies adopted quantitative easing. Which sequence best describes the intended transmission mechanism, and which common view of it is flawed?

The central bank buys long-term bonds with newly created reserves, pushing up their prices and lowering yields, which cuts borrowing costs and encourages investment and portfolio rebalancing. It is wrong to think QE simply hands newly printed cash to households.

  1. ACentral bank buys long-term bonds, which raises their prices and lowers yields, encouraging borrowing and investment; it is flawed to say QE directly prints cash for householdsCorrect
  2. BCentral bank sells bonds, raising yields; flawed to say it lowers rates
  3. CCentral bank raises policy rates to near zero; flawed to say it buys assets
  4. DCentral bank buys foreign currency only to lower interest rates domestically; flawed to say bond yields change
  5. Central bank lends to the government interest free; flawed to say bank reserves rise

Explanation

QE involves buying assets, mainly government bonds, with newly created reserves. Higher bond prices mean lower yields, reducing long-term borrowing costs and encouraging portfolio rebalancing and spending. It does not distribute cash directly to households. Selling bonds would be tightening, not QE.

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