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In the previous article, I have mentioned that the aims of the establishment of the Federal Reserve. If you wish to have a recap or haven’t read it, click the link below.
Click here for the article of Introduction to Federal Reserve.
Money Supply
The money supply is the most fundamental key element of the economy.
If there is too much money supply, there will be having severe inflation, and else, there will be having a deflation. Extreme inflation and deflation will be a disaster to the nation and its people.
Click here for further details on inflation and deflation.
I will introduce the details about the QE and QT down below.
Quantitative Easing – QE (Increase money supply)
Figure 2 above is a graph illustrating the total assets of the federal reserve.
To remind you that the Federal Reserve has the power to turn on the printing machine to print money from nowhere. The modern currency system in any country does not support by anything (Not supply by gold since 1971); therefore, the currency’s value keeps fluctuating every second.
The QE will increase the country’s inflation and reduce its purchasing power due to supply and demand.
Think of it as the supply of money increases, but the relatively the supply of goods does not increases. So the value of goods will go up, things will get much expensive to the public.
Do not confuse with the term ‘asset’. A large proportion of assets is terrible, and because of printing money and lend it to ordinary banks, not the ordinary average people.
The banks are hard to pay back the money they borrowed from the feds; it is one of the primary sources of power to encounter the financial crisis.
Quantitative Tightening – QT (Decrease money supply)
You will hardly see a nation is going to reduce its money supply. By lowering the asset size of feds (Figure 2) and reduce investing amount to the marks. Doing such action could be a slow process because it needs to calm down the general and institutional investors, stabilise, and reduce adverse effects.
In the recent decades, recent financial crisis, we could not see the feds could make such measures due to rigid enforcement, the swift reaction of investors.
A rising interest rate might also accomplish a similar result, lowering the interest rate and increasing the money supply to encounter a financial crisis.
Interest Rate
Federal Fund Rate
The Feds Fund Rate is a rate set by the Federal Reserve. It is in charge of the rate of borrow money from bank to bank.
This rate will also influence other rates, such as prime rate, Libor rate, Student Loans rate, Mortgage rate, etc.
Why do the banks need to borrow money from other banks?
Some may say, why do the banks need to borrow money from other banks.
I would say that sometimes the banks might lend out too much money and do not meet the reserve requirement regulation.
Reserve Requirement Regulation (Capital on hands)
Based on the Feds Fund Rate, why do the banks need to borrow money from other banks?
It is because the Federal Reserve has a requirement of minimum savings for the banks.
Think of it as if a bank lends 99% of its client’s money to others to acquire a high interest for earning a profit. Under this situation, suddenly, a large group of their customers would like to withdraw their money. The banks will not have enough money, forming a bank run and becoming insolvent, resulting in bankruptcy.
Statement and Signal
Official statement
This will be an official tool for communicating to the public, knowing about the feds, the policy, and general thought to shape and steer the economy.
Leak and clarification
In some cases, the news may have some information saying, increase of feds fund rate, print money, reduce money supply or other leaks some expectation of valuable data that will affect the economy (News may say the source is an insider of fed or something else).
Then after the market reacts to the news, the fed will have a further clarification for it.
Thoughts
I believe that do not believe the Federal Reserve or the government in 100%, in a normal situation, data do not lie, but people can lie.
Determine how to use and think the data, instead of just believing the word of the Federal Reserve.
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