My understanding is that the Fed bought billions of treasury bonds via QE1 and QE2. How did/does this prop up the stock market?
Lower interest rates increase the present discounted value of both future earnings and future dividends. So stocks have a higher intrinsic value. That’s one way of thinking about it.
Another take is that the Fed is exchanging money for safe bonds. Private investors redirect some of that money to riskier assets. Some of those riskier assets are stocks, whose price is bid up.
Another take on this is that by printing more money, the Fed is likely increasing inflation expectations, which means the nominal value of stocks must increase, even if we expect the inherent value to remain constant.
Another take on it is that by printing more money, the Fed is increasing aggregate demand in the economy – above and beyond interest rate effects, which are always slightly over-estimated, and are significantly misunderstood at the zero lower bound – making business conditions more robust, and therefore making businesses more valuable. The inherent value of the business increases, therefore the stock price increases.
People aren’t going to substitute away from safe cash in favor of riskier stocks unless their perceptions are changing about either inflation or business conditions, or both. In other words, you can divide the increase in stock prices into a real part, and an inflationary (nominal) part. And actually, the same break-down can be done for the effects of QE on the economy as a whole. QE will increase the number recorded for the country’s GDP, and part of the increase in the number will be due to inflationary effects, and part will be due to more real production. In our current situation, the real part of the GDP increase will be bigger than the inflationary part.
What QE2 accomplished was to push up the price of commodities. Basically, the FED gave out $800 billion to the banks-who promptly sank it into commodoites contracts. Thus, this idiotic government “accomplished” two things:
- a substantial increase in inflation
-a loss of purchasing power of the population
One of the main reason why “Tax Cheat Tim” Geithner wants out-he doesn’t want to stay on a sinking ship.
**Moderator CAUTION **
ralph.
If you want to anwer the question posed by the OP, then do it without the political commentary. You’re in General Questions, remember that.
samclem, Moderator
This is mostly nonsense.
All of the following FRED graphs can be re-sized with a RANGE of one year to better see more recent changes. (The URLs use brackets to change parameters, which screws up the VB coding.) QE2 has increased the US monetary base, on net, by about 700 billion dollars so far. There was a bigger headline number, but other factors are involved in net base money production. Of that 700 billion, a full 500 billion has remained completely inside the banks as excess reserves. That money has not gone anywhere, not into the commodities markets, not into real investment, not into people’s safes at home. That is completely idle cash. And even with the 200 billion that’s out and about, QE2 has nevertheless resulted in no appreciable increase in the rate of growth of the M2 money supply. The increase in the M1 appears to be picking up just a touch of steam.
Some of that money did go into commodities, but not nearly 800 billion worth. And commodities, just like stocks, can increase in value based on expectations of economic recovery, just as they can increase in value from expectations of higher inflation. (Although commodities are weird. They could also decrease in value, especially gold.) No direct money flow from the new dollars is technically necessary for this to happen.
Or, in the real world, a dramatic **reduction **in inflation. In fact, we were in deflation for a year, which is a situation that all economists dread. A small increase is the preferable number.
I agree with the others who say that the proper answer is that institutional stock buyers respond to perceptions of economy recovery. The outlook today is far better than it was in 2008 and the huge rise in stock prices reflects that, not a mythical increase because of printing money.