When people talk about the economy, they generally focus on government policies such as taxation and regulation. For instance, Republicans credit President Trump’s tax cuts for the seemingly booming economy and surging stock markets. Meanwhile, Democrats blame “deregulation” for the 2008 financial crisis. While government policies do have an impact on the direction of the economy, this analysis completely ignores the biggest player on the stage – the Federal Reserve.
You simply cannot grasp the economic big-picture without understanding how Federal Reserve monetary policy drives the boom-bust cycle. The effects of all other government policies work within the Fed’s monetary framework. Money-printing and interest rate manipulations fuel booms and the inevitable attempt to return to “normalcy” precipitates busts.
In simplest terms, easy money blows up bubbles. Bubbles pop and set off a crisis. Rinse. Wash. Repeat.
In practice, when the economy slows or enters into a recession, central banks like the Federal Reserve drive interest rates down and launch quantitative easing (QE) programs to “stimulate” the economy.
Low interest rates encourage borrowing and spending. The flood of cheap money suddenly available allows consumers to consume more – thus the stimulus. It also incentivizes corporations and government entities to borrow and spend. Coupled with quantitative easing, the central bank can pump billions of dollars of new money into the economy through this loose monetary policy.
In effect, QE is a fancy term for printing lots of money. The Fed doesn’t literally have a printing press in the basement of the Eccles Building running off dollar bills, but it generates the same practical effect. The Federal Reserve digitally creates money out of thin air and uses the new dollars to buy securities and government bonds, thereby putting “cash” directly into circulation. QE not only boosts the amount of money in the economy; it also has a secondary function.
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