Unit 4 · Level 1 · Central banks
The toolkit
Tool one is the policy rate: the interest rate banks pay to borrow central bank money, which anchors every other rate. Tool two, for when rates hit zero, is QE: creating reserves to buy bonds at scale, pushing long-term rates down too. QT is the same machine in reverse.
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What you get asked
Trace how a rate hike cools inflation.
This chain is 'transmission'. It works with a lag of a year or more. That is why policy feels like steering a ship, not a kart.
What is quantitative easing (QE)?
The central bank buys government (and some corporate) bonds with newly created reserves, lifting bond prices and pushing long-term rates down. No helicopters involved.
QE pushes bond prices up and long-term yields ___.
Price and yield are a seesaw: massive buying raises prices, which mechanically lowers yields. Cheaper long-term borrowing for everyone follows.
Match the tool to its role.
After 2008, the ECB and Fed built the QE/QT toolkit because their steering wheels were already turned to zero.
Quantitative tightening (QT) means the central bank…
Bonds mature and aren't replaced (or get sold), pulling liquidity back out of the system. QE in reverse: same machine, opposite gear. 🐜
The rest of this unit
The people who set the price of money: their mandate, their tools, and their words.