How does the purchase of securities by the Fed stimulate the stock market?

Two days ago (August 27th), the Fed chairmanBen Bernanke gave a speechin which he suggested that the Fed may involve themselves in “(1) conducting additional purchases of longer-term securities, (2) modifying the Committee’s communication, and (3) reducing the interest paid on excess reserves.”

I kind of get #2 and #3, but I don’t understand #1 at all. What securities is Mr. Bernanke talking about? Why would the purchase of these ‘securities’ increase investor confidence? (The stock market rose after Bernanke gave this speech).


Purchasing securities generally results in an increase in the money supply IF the money used to purchase them is created ex nihilo (from nothing) as opposed to using cash that is already on their balance sheet.

Unless there is inflation, an increase in the money supply is favored by the markets since it causes interest rates to fall or remain low. That means that businesses can borrow at a low rate and invest in projects that will return a much higher rate.