Why does easing boost the stock market?

Is this Ben Bernanke's WSO handle?

not sure if this is the full story but easing reduces interest rates, making it cheaper for firms to borrow and expand. Also, as yields go down on bonds, it becomes less profitable to buy new issuances so investors move into stocks where there is a higher return and the demand increases prices.

Good stuff

Also think about it this way; say "the stock market" has a nominal value of $1000 and there are $10,000 dollars in the entire economy, the stock market is worth 10% of the economy. If you turn on the presses and double the amount of cash in the system to $20,000 in real terms nothing has happened to the stock market (ceteris paribus) so to reflect that the stock market is still worth 10% of the economy, the nominal value has to rise to $2000.

Highly simplified version of what actually happens, but the salient conceptual idea remains intact.

EDIT: Just as an aside this concept is also pertinent to the current debate around Central Bank inflation vs nominal GDP targeting.

basically throwing cash around

Another way to think of it relates to commodities. If oil is at 100 today and tomorrow our currency loses 2% of its value (due to QE), then tomorrow oil will be $100/.98.

Easy....inflation

This administration's goal is to encourage inflation while causing lending to tighten. This has the net effect of higher paper equity values compared to debt obligations, particularly fixed interest debt obligations.

Why would they want to do this? Think about it.....who benefits?

Almost everything said on here is factually incorrect (except that point about trusting anything said in the financial media). It is important to distinguish between different types of government easing, monetary and fiscal, and within monetary policy between low rates and quantitative easing.

Fiscal easing (i.e. deficit spending) directly creates new financial assets in the economy (vertical money creation) and boosts corporate profits. It's easy to understand conceptually, when the government spends money (e.g. some defense item like an airplane), the company receives cash which it deposits in some bank account and creates a need to drain reserves. Simultaneously (or a few weeks later), the US government issues some bond to drain those reserves and the private sector gets a safe interest-bearing financial asset. Note: in the absence of such a bond sale, interest rates would fall to the rate paid on overnight reserves - by issuing debt, the US manipulates interest rates higher, not lower. Fiscal easing is highly effective at boosting GDP as it directly stimulates the economy and creates new financial assets. Too much easing, however, is inflationary. Namely, if the government eases / "prints" in excess of productive capacity, it can be highly inflationary (too much money chasing too few productive assets) and highly erosive to currency values.

Monetary easing comes in two primary forms for monetarily sovereign nations (i.e. countries with the ability to print money, such as US, UK, Japan, unlike the Eurozone countries). The first is by lowering short-term interest rates. Studies have shown that long term interest rates (10+ years) for currency issuers are 85 - 90% driven by short-term interest rates, with the remaining 10 - 15% driven by expectations of future short-term interest rates. Lower interest rates reduce the cost of credit, which can be stimulative to corporate balance sheets as well as boost housing values. The main transmission mechanism for monetary policy to the real economy is through the housing market, however. And with the housing market depressed over the past 5 years in the US during the household deleveraging, there has been little demand for credit, even at low interest rates. Note: bank lending is not reserve constrained, it is based on demand for credit by credit worthy borrowers (currently depressed in the US) as well as bank capital constraints. Banks lend first and then find reserves later. Bank loans simultaneously create deposits somewhere else in the banking system and economists call this horizontal money creation. In the United States, bank lending is the primary form of money creation and the depressed housing market in the US is the primary reason why money supply growth has slowed since the recession (reserves have nothing to do with it).

Quantitative easing is hardly easing at all as it simply is an asset transfer and has a negligible effect on the economy. The goal is to boost asset values and create a wealth effect and as the resulting fallout from QE2 showed, this brings about financial instability. Quantitative easing has two main effects on the economy (though both are negligible). On the one hand, it has the power to lower interest rates, however, the Fed has shown an inability to do this, as interest rates have risen during past instances of QE. The Fed would be effective at lowering long-term interest rates if they targeted price instead of quantity (i.e. announced that they would buy unlimited bonds to support a 1% 10 year interest rate instead of their current $85bn a month quantity target). Lower interest rates can lower the cost of credit, as explained above, but also lower net interest income to the private sector, as the government is a net payer of interest. If there is robust demand for credit, lower interest rates do stimulate the economy, however, in the present environment of household deleveraging with low demand for credit, lower interest rates have actually added an extra source of "drag" on the economy as interest income has fallen substantially.

The additional effect of quantitative easing is that the private sector receives a lower interest paying asset (reserves) in exchange for a higher interest paying asset (treasury / mbs bonds). This is the asset swap and can be thought of moving money from a savings to a checking account. This adds to the lost interest income to the private sector, the dollar quantity of which can be seen in the "profits" that the Fed has been turning over to the Treasury every year in the range of $75-80bn. These are profits that otherwise would have been earned by the private sector and have the effect of a "tax." While the first round of QE in the US did bring about some stability, later rounds have been largely useless as the economy was recovering anyway.

Which brings me back to the original question asked by the OP: why does easing boost the stock market. It depends. Fiscal easing does directly boost the stock market as government spending flows directly into corporate profits. Lower interest rates can boost the stock market by increasing valuations and possibly by boosting the economy through additional credit creation. Quantitative easing can boost the stock market if implemented during times of great financial instability (such as in 2008) but has a negligible effect on the actual economy and thus should have little ability to boost the stock market (though market not a reflection of reality, reflection of market participants' perceptions of reality). QE2 resulted in inflated asset prices which came crashing back to reality in May 2011. Market participants seem to have wised up to this with QE3 having a negligible effect on the stock market since its announcement. The resulting gains in the S&P have been largely driven by an improving economy as the household deleveraging comes to an end.

I thought it was because QE directly gives tons of cash to primary dealers and part of the money just gets invested in financial assets like stocks and commodities? Didn't know it was this complicated

I'm not sure you understood what I said. The Fed controls short term interest rates by setting the benchmark interest rate (Fed Funds rate) as well as the rate paid on excess reserves. Recent FOMC statements have pledged to keep interest rates low through the middle of 2015 (more recently, the FOMC has tied the decision to increase interest rates directly to the levels of unemployment and inflation - i.e. the Evans Rule). Several studies, notably by David Rosenberg of Gluskin Sheff, have showed long term interest rates to exhibit a 90% correlation with the Fed Funds rate. This makes sense, as long term interest rates in monetarily sovereign nations are simply an expectation of future short term interest rates.

As far as I can tell, quantitative easing has not lowered the rates of borrowing for individuals and companies. This has been accomplished through a near zero target rate and official language promising to keep the rate there indefinitely. And as mentioned in my post, lower interest rates have both a positive and negative effect on the economy, the latter of which dominates in a deleveraging environment.

Liquidity trap arguments are based upon the notion that banks lend reserves. This has been shown empirically to be factually inaccurate. Banks lend first and reserve creation follows. Economists that point to a liquidity trap are stuck in a Gold-standard way of thinking that no longer applies in the US or Japan.

This article does a decent job of explaining this concept: http://bilbo.economicoutlook.net/blog/?p=15168

Note: I do not completely agree with everything MMT says, but I believe they are correct when it comes to understanding many operational realities of our current monetary system.

The important point in all this is that there are a few explanations for the rise in the stock market when QE initiatives are announced. The first is that market participants expect easing to work, creating more jobs and consumption. If it's easier to borrow, companies should invest, hire more people, etc.

The second is inflationary, as more dollars chasing the same amount of securities will necessarily push up prices. Critics such as David Einhorn also point out that since real interest rates are at 0 or lower, savers are forced into equities to find reasonable returns on investments, lifting stock prices.

This posts explains it somewhat better than the Fed paper:

http://bilbo.economicoutlook.net/blog/?p=1623

I'm not trying to attack you...just this idea that even most mainstream economists have wrong. Even Nobel laureate Paul Krugman continues to demonstrate that he does not completely understand our monetary system (though he has shown an evolving grasp and better understanding over the past few years). The US monetary system is an incredibly complex system and where most economic theories get it wrong is by starting with a simple conceptual framework rather than trying to understand how the system actually operates and working from that.

I'm with macrotrad3r on this, although Ben himself did say that he was aiming for somewhat of a wealth effect with fed policy.

One important thing to keep in mind that isn't explicitly pointed out, but needs to be, is that the feds operations are not currently inflationary. Banks reserves are increasing as a result, but because lending is still limited, no money is entering into the market; that is why at points throughout the past year we had deflationary worries.

Whats important to ask is now when the fed comes out with dovish statements, why does the market rally? Seemingly a cop out answer, its because of expectations. Most market participants have rudimentary understandings of our monetary system (I recently talked to an higher up at an un-named bank who said that operation twist is expanding the balance sheet......could not be more wrong, its contradictory to the definition of operation twist to even assert so, but I digress.) and when the fed comes out with what people expect to be "good" for the economy, they begin to invest in the markets. Nothing but expectations, but as pointed out previously, perhaps no real economic growth may occur.

hahahaha "quantitative easing has no effect"

it's hilarious how people on this site can spew tons of technical jargon and then get some of the simplest stuff completely wrong

whatever you do, don't listen to macrotrad3r...

Note he ends with "While the first round of QE in the US did bring about some stability, later rounds have been largely useless..."

Suggesting that QE has no effect is analogous to suggesting the Fed has no power over the economy; QE is simply a tool to carry out monetary policy and is fundamentally similar to past policy actions. Rather, I think macrotrad3r is suggesting the "real" effects of QE are being overstated, going back to our thought that there exists discrepancies between the real economy and the financial markets, and QE seems to be exacerbating those discrepancies.