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 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. Therefore, it’s easier for borrowers to secure loans from banks and lenders.
- Easy money is a way for the Federal Reserve to build more cash within the economic system.
- Easy money is a representation of how the Federal Reserve can stimulate the economy using monetary policy, helping boost lending by pushing interest rates lower.
- The Federal Reserve looks to create easy money when it wants to lower unemployment and boost economic growth, but a major side effect of easy money is inflation.
How Easy Money Works
Easy money occurs when a central bank wants to make money flow between banks more easily. When banks have access to more money, interest rates charged to customers goes down because banks have more money than needed to invest.
The Federal Reserve typically lowers interest rates and eases monetary policy when the agency 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. Easy money is also known as cheap money, easy monetary policy, and expansionary monetary policy.
The Federal Reserve measures the need to stimulate the economy quarterly, deciding whether to create more economic growth or tighten monetary policy.
The Federal Reserve 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 when inflation is relatively low.
Requirements for Easy Money
An 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 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 Federal Reserve and goes down to consumers.
As an example, during an easing of monetary policy, the Federal Reserve may instruct the Federal Open Market Committee (FOMC) to purchase Treasury-backed securities on the open market. 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, in turn, stimulates other economic activities. The process continues indefinitely until such time the Federal Reserve decides to tighten monetary policy.