The government’s “ingenious” solution to end the Great Recession was to recreate the same wealth effect that engendered the credit crisis to begin with: The definition of the wealth effect is an increase in spending that comes from an increase in the perception of wealth generated from equities and real estate.
Our Treasury and Federal Reserve figured the best way to accomplish this was to rescue the banking system by taking interest rates to zero percent, buying banks’ troubled assets, and recapitalizing the financial system. Most importantly, our government loaded banks with excess reserves. This process, known as quantitative easing (QE), pushed lower long-term interest rates through the buying of Treasury Notes, Bonds. and Agency MBS.
It is imperative to understand the QE process in order to fully understand why the tapering of asset purchases will lead to a collapse in asset prices and a severe recession.
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