What is Quantitative Easing?

By Kiernan Brown Updated on 9/23/2013

I was recently asked "What is Quantitative Easing and why does it keep rates low?"  In layman's terms, Quantitative Easing is when a central bank buys financial instruments (Bonds & Mortgage Backed Securities (MBS)) from commercial banks and other private firms. The purchasing of these instruments increases the amount of money available in the markets, and when this money is used to buy MBS's it creates a demand for these securities at a lower supply level.  When fewer Bonds & MBS's are available and they are being bought up and expected to still be bought up, interest rates can decline.  Over the last 5 years the Federal Reserve has been purchasing 80 billion in Bonds & MBS's every month.  This has kept the bull market churning and mortgage rates low.  When the Fed started talks of Tapering (buying fewer Bonds & MBS), interest rates spiked to a 3 year high and the stock market dropped one thousand points.  Last week when the Fed announced that it will not start tapering, interest rates took a measurable dip and the stock market rallied.  Investors love the idea of an increase in capital being available, and are willing to continue investing in Bonds and MBS, knowing that the Fed will still be buying them in the near future.  Rates will stay stable and low for a little while longer.