Most articles describe QE as purchasing government securities on the market. I thought that was what ordinary day to day operations of the central bank were in their efforts to maintain a target interest rate. So if they aren't buying government securities day to day, what is it they do to manage the bank lending rate?

  • $\begingroup$ about 3 trillion dollars $\endgroup$ – Lassie Fair Dec 15 '16 at 20:37

In usual open market operations, the central bank will create money, use this money to buy short term Treasury securities from maybe banks, individuals, institutions in the open market. This creates more demand for these securities. Hence their price goes up and yield goes down. This newly generated money goes into the banking system. With more money, banks have more cash and have more reserves. With more reserves banks may be more willing to lend to each other and to individuals also. This lowers the short term inter banking interest rate. This way, there is more money in the system and there is a downward pressure on rates. With short term Treasuries, central bank is less exposed to the interest rate risk.

In quantitative easing (QE), both the purpose and the mechanism are different. First of all, QE usually will be performed in a situation which is not 'typical' money supply shortage or economic activity slowdown. This will either happen in a crisis where aggressive boost is required or when central bank has run out of its primary weapons. Maybe it already lowered interest rates to zero. The central bank in these situations might buy securities of different kinds which can be long term treasuries, private securities, securities in a particular area of market which, the central bank thinks, needs to be revived. This certainly will not just increase money into the system, but further lower the yield and ease out specific markets such as mortgage based securities by reducing the risk spread.

One other criterion is the size of the increase in balance sheet of central bank. In QE there is usually a much larger change in the balance sheet of central bank. Also, as there are different kinds of securities (including long term securities) in the assets of central bank which are not necessarily treasuries or highly rated securities, the central bank itself is exposed to more risk.

Ben Bernanke said in 2009 that, the QE they exercised was not pure QE but credit easing, because in pure QE, the central bank will not discriminate between what securities it is buying. However, according to him, Fed did target few specific markets. Targeting few specific markets is more like credit easing and not pure QE.

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  • $\begingroup$ Would QE have any effect on the interbank lending rate (if that rate was significantly above zero)? $\endgroup$ – erv Dec 15 '16 at 14:01
  • $\begingroup$ Yes, it will have. You are pumping in more money into the system and that money goes into the banking system only. Q.E will work the same way when the inter-bank rates are higher and are not responding to the rate cuts by the central bank. $\endgroup$ – Sub-Optimal Dec 15 '16 at 20:00
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    $\begingroup$ So to be clear, despite that, QE isn't really about fiddling with rates. It's about injecting large amounts of liquidity, whereas regular central bank operations are more simply about the target interest rate? $\endgroup$ – erv Dec 16 '16 at 3:59
  • $\begingroup$ Yes. The rate is not the only target for Q.E because it may be zero already. $\endgroup$ – Sub-Optimal Dec 16 '16 at 5:45
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    $\begingroup$ More precisely, you can say that Q.E could be performed when the inter-bank rates are no longer in control of the central bank. They could either be zero or too high and not responding to central bank calls. Q.E would also consist of various actions at the same time such as Fed opening up the discount window for the investment banks also and opening up of foreign credit swaps. All these actions will effect the inter-bank rates also eventually but that was not the objective in the first place. $\endgroup$ – Sub-Optimal Dec 16 '16 at 6:00

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