What Is Easy Money?
Easy money, in academic terms, denotes a condition in the money supply and monetary policy where the U.S. Federal Reserve (Fed) allows cash to build up within the banking system. This lowers interest rates and makes it easier for banks and lenders to loan money to the population.
Easy money is also known as cheap money, loose monetary policy, and expansionary monetary policy.
Key Takeaways
- Easy money is when the Fed allows cash to build up within the banking system—as this lowers interest rates and makes it easier for banks and lenders to loan money.
- Easy money is a representation of how the Fed can stimulate the economy using monetary policy.
- The Fed looks to create easy money when it wants to lower unemployment and boost economic growth, but a major side effect of doing so is inflation.
- When money is easy (i.e., cheaper) to borrow, it can stimulate spending, investment, and economic growth.
- If easy money persists for too long, however, it can lead to high inflation.
Understanding Easy Money
Easy money occurs when a central bank wants to make money flow between banks more easily. When banks have access to more money, the interest rates charged to customers go down because banks have more money than needed to invest.
The Fed typically lowers interest rates and eases monetary policy when it wants to stimulate the economy and lower the unemployment rate. The value of stocks will often rise initially during periods of easy money—when money is less expensive. But if this trend continues long enough stock prices may suffer due to inflation fears.
The Fed measures the need to stimulate the economy quarterly, deciding whether to create more economic growth or tighten monetary policy.
The Fed weighs any decisions to raise or lower interest rates based on inflation. If an easy monetary policy looks to be causing a rise in inflation, banks might keep interest rates higher to compensate for the increased costs for goods and services.
On the flip side, borrowers might be willing to pay higher interest rates because inflation reduces a currency’s value. A dollar does not buy as much during periods of rising inflation, so the lender may not reap as much profit compared with when inflation is relatively low.
Easy Money Tools and Methods
The biggest policy tool to spark easy money is to lower interest rates, making borrowing less costly. Another easy monetary policy may lead to lowering the reserve ratio for banks. This means banks have to keep less of their assets in cash—which leads to more money becoming available for borrowers. Because more cash is available to lend, interest rates are pushed lower. Easy money has a cascade effect that starts at the Fed and goes down to consumers.
During an easing of monetary policy, the Fed may instruct the Federal Open Market Committee (FOMC) to purchase Treasury-backed securities on the open market (known as open market operations, or OMO). The purchase of these securities gives money to the people who sold them on the open market. The sellers then have more money to invest.
Banks can invest excess money in a number of ways. Lenders earn money on the interest charged for money lent. Borrowers spend the loans on whatever they choose, which stimulates other economic activities. The process continues indefinitely until the Fed decides to tighten monetary policy.
Easy vs. Tight Monetary Policy
Easy money and the policy measures that help make money easier to borrow can be contrasted with tight monetary policy, which leads to "dear money"—or money that is expensive to borrow or hard to come by. Tightening monetary policy is often done in response to an overheating economy, characterized by high inflation, low unemployment, and high GDP growth.
Tools and methods for enacting tight, or contractionary, policy are effectively the opposite of easy or loose policy measures. These include raising interest rates, selling securities in the open market (thus removing money from circulation), and raising the reserve requirements for banks.
Advantages and Disadvantages of Easy Money
While easy money is used to stimulate the economy and make borrowing less costly, too much easy money can lead to an overheated economy and rampant inflation. In fact, the central bank's job is to turn off the easy money spigot once an economic recovery has gained traction and price levels begin to rise.
Pros
Easy money can stimulate a flagging economy.
It helps incentivize spending and investment.
Easy money is often associated with rising stock markets and asset prices.
Cons
Too much easy money can cause the economy to overheat.
It can incentivize over-investment in projects with poor outlooks.
Easy money can lead to high inflation.
Discourages saving since interest rates on deposit accounts are low.
Example of Easy Money: The Great Recession
Easy money has been a facet of the economies of much of the developed world since the 2008-09 financial crisis and the Great Recession that followed. At the height of the crisis, stock markets crashed, unemployment soared, bankruptcies increased, and several large financial institutions failed.
During that period, the Fed along with many other central banks around the world scrambled cut interest rates to effectively zero, cut banks' reserve requirements to effectively zero, and pumped money into the economy via open market operations and quantitative easing (QE).
Many economists agree that the scope and duration of the Great Recession, while among the deepest on record, was greatly reduced as a result of these easy money efforts.
Frequently Asked Questions
What Is a Short-Term Effect of an Easy Money Policy?
While there is often a time lag between a new monetary policy measure and its effects on the economy, one short-term effect is lower interest rates, making loans cheaper for borrowers. As borrowers take advantage of these lower rates, they consume more and purchase large assets like homes more readily. The longer-term effect of this increased consumption is a rise in corporate profits and economic growth.
What Tools Does the Fed Use to Create an Easy Money Policy?
The Fed and other central banks have several tools at their disposal to promote easy money. These include lowering interest rates, lowering the reserve requirement for banks, opening the discount window, purchasing assets through open market operations (OMO), and quantitative easing (QE) measures.
What Is Quantitative Easing?
Also known as QE, quantitative easing allows central banks to increase the money supply by growing their balance sheets through the purchase of different types of assets than they normally would via OMO. These might include longer-dated Treasuries, non-Treasury debt, equities, or alternative assets like mortgage-backed securities (MBS).
How Do Easy Money Policies Affect Investors?
Stock markets tend to rise when there is easy money, as yields for depositors and other savers fall, they may seek yield elsewhere in the markets. Easy money also helps boost most firms' profits and allows them to borrow and invest more cheaply. (One exception, however, is the financial sector, which often benefits from rising interest rates instead since they make loans.) In addition, bond prices tend to rise as rates fall, benefitting fixed-income investors.
