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I don't seem to understand the effects of QE.
Fed uses open market to purchase long-term government bonds which pushes up the demand for bonds and drives up the price of bonds. However, this injection of money into the market can also drive up the inflation expectation. This expectation makes people demand higher interest from long-term bonds lowering the current bond price.
Am I correct on this analysis? If so, what's the total effect of these two forces?
The classic definition of inflation is "too much money chasing too few goods." Low rates and QE were intended to help revive a stalled economy, but unfortunately, demand has not risen, but rather, the velocity of money has dropped like a rock.
At some point, we will see the economy recover and the excess money in the system will need to be removed to avoid the inflation you suggest may occur. Of course, as rates rise to a more normal level, the price of all debt will adjust.
This question may not be on topic for this board, but if we avoid politics, and keep it close to PF, it might remain.
QE is artificial demand for bonds, but as always when there are more buyers than sellers the price of anything goes up. When QE ends the price of bonds will fall because everyone will know that the biggest buyer in the market is no longer there.
So price of bonds will fall. And therefore the interest rate on new bonds must increase to match the total return available to buyers in the secondary market.
