Quantitative easing (QE) is a form of monetary policy wherein central banks, such as the United States Federal Reserve, purchase securities in the open market. This action aims to reduce interest rates and boost the money supply. By doing so, it helps increase bank reserves, fosters liquidity, and encourages lending and investment.
Key Takeaways
- Quantitative easing is used by central banks to increase the domestic money supply and stimulate economic activity.
- Central banks purchase government bonds and other financial instruments, such as mortgage-backed securities (MBS).
- QE is commonly implemented when interest rates are near zero and economic growth is stalled.
- The Federal Reserve implements QE policies in the United States.
Understanding Quantitative Easing
Quantitative easing is often applied when interest rates are close to zero and economic growth is sluggish. Central banks have a limited toolkit, including interest rate adjustments, to influence economic growth. When rate decreases are not viable, central banks increase the money supply by buying government bonds and other securities, injecting liquidity into the economy. This enhances bank reserves, lowers interest rates further, and facilitates easier borrowing terms.
Government fiscal policy can also be employed simultaneously to broaden the money supply. While the Federal Reserve can influence the money supply, the U.S. Treasury Department can introduce new money and tax policies. This approach can direct funds into the economy both directly and indirectly.
Does Quantitative Easing Work?
Many economists believe the Federal Reserve’s QE initiatives helped stabilize the U.S. and global economy after the 2007-2008 financial crisis. While QE effectively lowers interest rates and boosts stock markets, its broader economic impact remains inconclusive. Quantitative easing is known to benefit borrowers and investors more than savers and non-investors, presenting both pros and cons.
For instance, during the COVID-19 pandemic, the Federal Reserve significantly increased its holdings, accounting for 56% of security issuance through early 2021.
Risks of Quantitative Easing
Inflation
Increasing the money supply runs the risk of inflation. Central banks stay alert to the time lag—usually 12 to 18 months—between the increase in money supply and the inflation rate. An ineffective QE could trigger stagflation: high inflation rates coupled with high unemployment.
Limited Lending
Even with increased liquidity, central banks cannot compel banks to enhance lending activities, nor can they force businesses or individuals to borrow and invest. This scenario may create a ‘credit crunch,’ where available cash is held back due to uncertain economic conditions.
Devalued Currency
Expanding the money supply might devalue the domestic currency. While a devalued currency can make exports cheaper and more competitive globally, it simultaneously raises the cost of imports, influencing production and consumer prices.
Real-World Examples of Quantitative Easing
United States
In response to the Great Recession, the U.S. Federal Reserve implemented a QE program between 2009 and 2014. As a result, U.S. bank reserves soared to over $4 trillion by 2017. The Fed reacted similarly in 2020 to counteract the economic impacts of COVID-19. However, a notable policy shift occurred in 2022, focusing on interest rate hikes and asset reduction to counter inflation.
Europe and Asia
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Japan: Post the Asian Financial Crisis of 1997, the Bank of Japan launched a robust QE initiative to combat deflation. This involved purchasing Japanese government bonds, private debt, and stocks, which led to a temporary GDP rise.
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Switzerland: Amid the 2008 financial crisis, the Swiss National Bank employed QE, eventually owning assets exceeding the country’s annual economic output. The impact of this strategy on economic recovery remains debated.
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United Kingdom: The Bank of England embarked on a QE program in 2016 to mitigate Brexit’s potential economic effects, buying £60 billion in government bonds and £10 billion in corporate debt. However, the precise role of this initiative in fostering economic growth remains unclear.
How Does Quantitative Easing Work?
Quantitative easing involves a central bank increasing financial system liquidity by purchasing long-term government bonds from major banks. This action encourages banks to lend or invest more freely, boosting economic growth.
Is Quantitative Easing Printing Money?
Detractors argue that QE resembles money printing, leading to hyperinflation historically. Advocates counter that QE involves banks acting as intermediaries rather than directly dispersing cash to businesses and individuals, thus posing minimal risk of rampant inflation.
How Does Quantitative Easing Increase Bank Lending?
By substituting bonds with cash in the banking system, QE effectively raises the money supply, facilitating banks to release more capital. This enables further loan underwriting and asset purchases.
The Bottom Line
Quantitative easing is a monetary policy strategy where central banks buy securities to enhance the money supply, which in turn boosts bank lending and investment. Although QE has been undertaken globally, its impacts on national economies are subject to ongoing debate.
Related Terms: Federal Reserve, monetary policy, inflation, interest rates, bank lending, recession, deflation.
References
- Federal Reserve Bank of St. Louis. “Quantitative Easing: How Well Does This Tool Work?”
- Congressional Research Service. “The Federal Reserve’s Response to COVID-19: Policy Issue”. Pages 24-26.
- Brookings. “Recession Remedies: Lessons Learned From Monetary and Fiscal Policy During COVID-19”.
- Federal Reserve Bank of St. Louis. “Examining Long and Variable Lags in Monetary Policy”.
- Congressional Research Service. “Federal Reserve: Unconventional Monetary Policy Options”. Page 11.
- Congressional Research Service. “Monetary Policy and the Federal Reserve: Current Policy and Conditions”. Pages 13-14.
- Board of Governors of the Federal Reserve System. “Federal Reserve Issues FOMC Statement, March 15, 2020”.
- Board of Governors of the Federal Reserve System. “The Federal Reserve’s Responses to the Post-Covid Period of High Inflation”.
- Bank for International Settlements. “Central Bank Balance Sheet Expansion: Japan’s Experience”. Pages 134-137.
- The World Bank. “GDP (Current US$) - Japan”.
- European Union. “Independence With Weak Accountability: The Swiss Case”. Pages 9-10.
- Jordan, Thomas J. et al. “Ten Years’ Experience With the Swiss National Bank’s Monetary Policy Strategy”. Swiss Society of Economics and Statistics 2010, vol. 146 no. 1, pp. 47-57.
- Bank of England. “Bank Rate Cut and Other New Measures: What Do They Mean?”
- Office for National Statistics. “Business Investment in the UK: April to June 2018 Revised Results”.
- Bank of England. “QE at the Bank of England: A Perspective on Its Functioning and Effectiveness”.
- FasterCapital. “Money Printing: Money Printing Gone Awry: The Catalyst for Hyperinflation”.
- Federal Reserve Bank of St. Louis. “Quantitative Easing: How Well Does This Tool Work?”
