Effect of Quantitative Easing on Stock Markets

Quantitative easing (QE) has an effect on lot of areas within the economy. However, one of the most important effects occurs in the stock markets. The recent rounds of quantitative easing (QE) by the Fed lead to a lot of volatility in the stock market.

Prices rose and dropped in value on the news of quantitative easing (QE). However, investors who were not well versed with this policy because of its short history were left curious as to what is happening and why. This led to many experts to come up with many theories as to why this is happening. This article will explain the various viewpoints that have arisen in the past few years regarding the relationship between quantitative easing (QE) and the stock markets.

Mainstream Point of View

The mainstream point of view suggests that the effect of quantitative easing (QE) is pretty straightforward in the stock markets. When there is an expansionary quantitative easing (QE) policy announced, the market becomes bullish and stock prices begin to go up. On the other hand, quantitative easing (QE) tapering contracts the economy, then the markets become bearish and stocks tend to go down in value.

The logic behind this is said to be relatively simple too. Well, according to mainstream economists, quantitative easing (QE) uplifts a depressed economy. Therefore investors see it as a sign of better times ahead and make a beeline to buy the stocks expecting growth in the markets. However, the corollary of the same theory would also mean that investors will react negatively to a quantitative easing (QE) tapering program. The execution of a quantitative easing (QE) tapering is likely to cause a drastic fall in the value of stocks because it may mean that investors would have to look forward to times which are hard for business.

Therefore, the theory speaks for itself. In the short run, quantitative easing (QE) causes a boom. However, since quantitative easing (QE) cannot continue forever, sooner or later, quantitative easing (QE) ends causing a bust in the economy.

Debasement Point of View

Contradictory to the mainstream view of quantitative easing (QE) is the debasement point of view. The conclusions of the debasement point of view are also similar to that of the mainstream point of view. However, the rationale behind the conclusions varies widely.

The debasement point of view believes that quantitative easing (QE) is injecting money into the system. The new money derives its value because of the loss of purchasing power of the old money in circulation. Therefore, the markets adjust their prices to reflect this phenomenon.

For instance, the stocks rise in value when the news of a quantitative easing (QE) occurs. This is because as quantitative easing (QE) occurs money loses its value and therefore more money is required to buy the same goods.

On the other hand, when news of quantitative easing (QE) tapering occurs, the stocks fall in value when quantitative easing (QE) tapering occurs since this reduces the money supply and hence increases the real value of money.

According to the debasement point of view, the rise and fall in the stock market is actually due to fluctuating value of money and has got nothing to do with the value of stocks.

Expansionary Point of View

The expansionary point of view regarding quantitative easing (QE) also states that quantitative easing (QE) makes the economy go upwards whereas the lack of quantitative easing (QE) makes it spiral downwards. The logic behind this is based on the changes which happen in the real economy.

For instance, when there is more money in the system, people will buy more goods and services. This translates into higher demand which further translates into even higher demand. Therefore, because of the increasing demand companies tend to prosper and as a result the stock market goes up.

The fall in stock values as a result of the quantitative easing (QE) tapering can be explained similarly. When money is sucked out of the system, the demand is depressed and employment is reduced which further affects the confidence and leads to more depression in the economy. Therefore, companies witness falling sales and as a result the stock market goes down in value.

Interest Rates Point of View

The last point of view that we will be discussing is based on interest rates. It is a combination of multiple other theories. Basically, this point of view believes that quantitative easing (QE) causes the real interest rates in the economy to drop. As a result, when quantitative easing (QE) is announced, demand goes up, employment goes up and so the stock markets go up.

However, it identifies interest rates drop as being the critical factor in the boom phase. For instance, if somehow quantitative easing (QE) did not lead to real interest rate drop, it would not cause a boom in the economy.

The same logic can be further extended to explain the downturn that follows when quantitative easing (QE) tapering takes place. According to this theory markets become depressed only because real interest rate rises. Everything else is merely a side effect of the rising interest rates.

Thus the theories are unanimous about the effect of quantitative easing (QE). There is no doubt about the fact that an expansionary quantitative easing (QE) causes the market to rise whereas a decision to undergo quantitative easing (QE) tapering makes it drop. The causes that lead to this effect are believed to be different by different theories.