I’ve been hearing these terms but don’t really understand what they mean, when and why are they used by the government and how exactly they affect prices and general standard of living.
In: 45
I don’t think 5 year olds should be anywhere near fiscal policy, but quantitative easing and tightening are a result of 5 year old thinking.
So here goes:
The whole economy doesn’t work like your personal bank account does. People, businesses and governments actually buy and sell many times more than they actually have in their bank accounts or under their matresses.
They do this by selling and buying promises for money or something that can be turned into money at some point in the future.
How much someone should pay for a promise of $100 a year from now really depends on how difficult we collectively think it’s going to be to find/earn $100 in the next year. It might be worth $105 today to be guaranteed $100 next year.
Some of these promises are bought with actual cash money, but most of them are bought by trading other promises. So it’s possible to play a game of hot potato buying and selling promises, but whoever gets stuck with the promise for $100 on the day it’s due has to actually cough up $100 to whoever happens to be holding that piece of paper on that day.
How much we collectively think a promise of cash in the future is worth depends on how easy or hard we think it is to find that cash some other way. The way that banks and governments see that is by looking at how many of all the government promises out there (Treasury bills) get paid with cash vs. other promises. The government is always selling more promises for cash in the future than it receives cash from taxes. (You can’t pay your taxes with promises, the IRS only accepts US dollars).
This is where quantitative easing and tightening comes in. If the government increases the amount of promises it sells, then it’s easier to borrow money, and we collectively do more of that and use it to buy stuff, but the actual value of that money is less. This is called quantitative easing. The government is basically creating more money out of thin air by selling promises, and that makes people buy
The $100 that you borrowed buys a whole cart of groceries today, but when you pay it back it only buys 98% of what it did, even though it’s still $100.
If the Fed starts buying back promises that the government made (Treasury bills), then they won’t have to pay out that money when they come due and there are fewer of them around for other people to buy. This is called quantitative tightening. The government is reducing how much money will be around in the future, and this makes it more expensive to buy promises, which means that people borrow less and buy less. It also makes prices go up because if you are borrowing money to buy inventory before selling it, the cost of borrowing gets reflected in prices.
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