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IAI Actuarial Core Principles · Business Economics · Recent macroeconomic history

In the years after 2008, the Bank of England and the US Federal Reserve bought large quantities of government bonds with newly created central bank reserves. Which description best captures the primary intended transmission mechanism of this quantitative easing (QE)?

QE aimed to lower long-term yields and lift asset prices once short-term rates were near zero. By buying bonds with newly created reserves, the central bank eased financial conditions and encouraged investors to move into riskier assets, stimulating borrowing, spending and investment.

  1. ARaising the policy rate above its natural level to reduce inflation expectations
  2. BLowering long-term yields and raising asset prices to stimulate spending when the short-term policy rate was near zeroCorrect
  3. CReducing the government's budget deficit by lowering tax receipts
  4. DFixing the exchange rate against a basket of currencies by selling foreign reserves
  5. Forcing commercial banks to hold higher capital ratios against government bonds

Explanation

QE was used when the short-term policy rate was close to its lower bound. Central bank purchases of long-dated bonds push up their prices and lower yields, which also encourages investors to rebalance into other assets, easing financing conditions. The other options describe tightening, fiscal policy, exchange-rate pegging or regulation, none of which is QE.

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