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To boost the economy, the central bank can do it either by lowering down the interest rate nor carry out QE. But QE objective is to lowered the interest rate also so banks can give out more loan. This seem to be similar.But i believe it's different. So what are the differences here. I am really confused.

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  • $\begingroup$ I would just like to add that I am not sure this question is relevant for Q.SE. $\endgroup$ – experquisite Dec 4 '15 at 0:24
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There is not a single 'interest-rate' to reduce, there are various interest rates in play.

The central bank mandate is usually to control CPI or a similar measure of inflation (e.g. Bank of England's 2% inflation target for GBP). There are various tools for them to do this, including QE and setting the central bank rate.

However, at the moment, the central bank interest rate (i.e. the rate at which banklike institutions can borrow from the central bank) is very low, so this tool has limited use, and lowering it further reduces future opportunities to use it.

QE pushes to increase price inflation by increasing general monetary inflation; this is not a direct relationship, as prices for many everyday items are much more related to the disposable incomes of the population than to the inflation of the currency.

The rates at which retail banks offer loans and savings account, which you are suggesting the central bank could alter, are to do with the default risk of the customer and the investment rates the bank can achieve. You don't want to intervene in bank's estimations of customer credit risk, so that just leaves the savings rates which the bank offers. These could only be increased if the bank could invest at higher rates, which are largely governed by that central bank rate. Given that these rates are already close to zero, it would be hard to justify forcing a bank to lower them either.

There is an economic argument that the purpose of the central bank is to corner the money supply so that it can then manipulate it as needed. Arguably this has been achieved by the US, UK and EU central banks at least, in that their overnight funding rates and rate targets strongly determine the interbank overnight rates.

At the moment, central bank rates are low to stimulate investment and spending; higher interest rates penalise borrowers and reward savers, whereas lower rates reward spending and penalise saving. With central bank rates low, there is a risk of inflation running too low and possibly entering deflation which strongly disincentivizes spending (you could wait and pay less). So QE is the tool that central banks have opted for to drive inflation higher without raising central bank rates. It is not the only tool left, as we have seen other measures designed to temper for example mortgage borrowing by adding limits to how banks can lend, etc.

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Good question. to make it short: same Aim, but just different ways to fullfill a goal. if you (or Lender of last resort) create(s) an exogenous shock by lowering directly rates, the cost of interbank money is de facto reduced and you expect a positive externality in real economy by providing more loans towards economic agents (companies, etc.). However with QE, you or Central bank increase(s) balance sheets by buying more Treasury assets (for instance, government bonds, etc.) and therefore increasing the money supply for different purposes:

1 - Sustain economic growth with a willingness to generate inflation

2 - Ensure financial stability by putting a downward pressure on yields (impacting yield curves). This affects financial futures markets too

3 - Rescuing banks or any other financial institutions by providing them with more money (cash) in an attempt to mitigate the consequences of a severe crisis. This could be embodied by taking toxic assets as collateral for some time in the wake of repurchase agreements (repo or reverse repo), as we've seen recently.

Hope it helps

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  • $\begingroup$ One more reason is that all banks are not alike. Some bank assets are more profitable than others. Some banks might offering higher interest rate than others. Intervention through indirect routes provides bank flexibility to change interest rate according to their needs. competition among all banks put pressure on all bank to respond. $\endgroup$ – Neeraj Dec 1 '15 at 10:30
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The traditional tool of central banks is the direct control of interest rates. The interest rate being controlled is usually the short dated interbank rate ( federal funds rate in the US).

If, in a severe recession, the short rates have already been reduced to zero, we have seen central banks turn to QE. Under QE, the central bank typically buys government bonds in the open markets. This has the effect of influencing longer term rates such as bond yields and mortgage rates to be lower. Hence the major difference is that QE affects long dated rates whereas traditional Fed policy is directed at short rates only.

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