Impact of Quantitative Easing on the US Dollar

Research analyst Anthony Grech offers in-depth analysis into a range of topics so you can improve your knowledge of the financial markets. These free topical reports, accessible to account-holders only, track the historic performance of various markets.

Here's a summary of our latest report on Quantitative Easing. You can access the full version in the TradeSense Databank found in the PureDeal platform. See other research articles by Anthony Grech.

Quantitative Easing: Impact on the US Dollar

Faced with the current economic crisis in the US, the Federal Reserve has, since 2007, cut its benchmark target rate from 5.25% to zero to 0.25%.

It has also introduced various fiscal and economic stimuli as well as made numerous direct investments into banks.

More significantly, the Federal Reserve recently said it will buy up to $300 billion worth of long-term Treasuries over a six-month period and more than double its mortgage debt purchases to $1.45 trillion. In doing so, the US Fed effectively adopted an unorthodox form of monetary policy, commonly known as Quantitative Easing (QE).

Quantitative Easing (QE)

Quantitative easing (QE) is a non-standard form of monetary policy whereby central banks use newly created money to purchase securities, particularly long-term government bonds, with the objective of reviving credit markets and eradicating deflationary pressures. This is usually done by flooding financial institutions with excess liquidity, normally through lower interest rates.

Impact of QE on the US dollar

Economists fear that by adopting quantitative easing, the Federal Reserve has put the US economy into a precarious situation: many are concerned the US Fed may not be able to remove excess liquidity from the system once the economy has stabilised, leading to elevated inflationary pressures and, possibly, hyperinflation.

Another fear is that the creation of new money increases the supply of a currency in circulation, meaning that the nominal value of every unit of currency will decrease. The Federal Reserve’s actions resemble steps taken by the Bank of Japan (BoJ) when it formally announced its QE policy in March 2001.

During this period, the BoJ lowered interest rates to almost zero and the yields on 10-year Japanese government bonds tumbled as the central bank bought assets in order to lower credit spreads. This led to a significant expansion in the country’s monetary base (currency in circulation) and depreciation in the Japanese yen, which fell by more than 20% against the pound, euro and Australian dollar between 2001 and 2007.

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The above comments do not constitute investment advice and IG Index accepts no responsibility for any use that may be made of them.