When Central Banks Inject Cash Into Markets

CFA Level I
#1

Hello all, Question regarding market liquidity With the world’s Central Banks pumping cash into the money markets, in an effort to maintain liquidity, what would be the consequences be of such actions? (cons and pros) Thanks

#2

I think long discussion has been opened…does anybody has time before exams?? :))

#3

First Liquidity is increased. Next money suppy will increase and lot action in the market

#4

Concept checker… The central banks around the world that have just recently injected the economy with money (extra liquidity), was this done through buying government securities? Thanks

#5

The potential con is inflation - more money chasing same amount of supply, price levels go up. But, that is weighed against the risk of (severe?!) economic downturn, and higher money supply means lower interest rates means more available credit, which in turn leads to more investment. But credit can become too easy, and, well, some would certainly argue that is how we got into this mess in the first place. :wink: There is no free lunch, there are no solutions. Only tradeoffs to be made.

#6

Thanks Chi Paul, but how was this money “pumped” into the markets?

#7

Yes, as you said, purchasing government securities is the typical way it is done. Simple example: government buys T-Bills from a bank so that bank now has more cash in reserves that it can lend out.

#8

Chi Paul Wrote: ------------------------------------------------------- > Yes, as you said, purchasing government securities > is the typical way it is done. > > Simple example: government buys T-Bills from a > bank so that bank now has more cash in reserves > that it can lend out. Unfortunately, this time around, the majority of the money is coming from China and the middle east, the US treasury just sold $40 billion and another $80 short term notes to mainly China and the middle east as the buyers.

#9

^ That would reduce the available money. When the gov’t injects liquidity, the don’t buy bonds, they borrow them in the repo market. If te gov’t bought and sold bonds everytime they wanted to change the money supply then there would be a 900-lb gorilla in the bond market all the time acting predictably. We could all make good money on that. Instead, they reverse repo bonds which is providing liquidity not buying bonds.

#10

Wait, I’m confused… I recall from my econ classes (way back when!) that the Fed’s most commonly used method is open market operations in which they buy/sell bonds to achieve the desired target rate??? Edit - my mistake, we are talking about providing liquidity, not target rates. Nevermind!