What is ‘Quantitative Easing’
Quantitative easing is an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. Quantitative easing is considered when short-term interest rates are at or approaching zero, and does not involve the printing of new banknotes.
BREAKING DOWN ‘Quantitative Easing’
In quantitative easing, central banks target the supply of money by buying or selling government bonds. When the economy stalls and the central bank wants to encourage economic growth, it buys government bonds. This lowers short-term interest rates and increases the money supply. This strategy loses effectiveness when interest rates approach zero, at which point banks have to implement other strategies to kick start the economy. Another strategy they can use is to target commercial bank and private sector assets in an attempt to spur economic growth by encouraging banks to lend money. Note that quantitative easing is often referred to as “QE.”
The Drawbacks of Quantitative Easing
If central banks increase the money supply too quickly, it can cause inflation. This happens when there is increased money but only a fixed amount of goods available for sale when the money supply increases. A central bank is an independent organization responsible for monetary policy, and is considered independent from the government. This means that while a central bank can give additional funds to banks, they can’t force the banks to lend this money to individuals and businesses. If this money does not end up in the hands of consumers, the lending to the banks will not impact the money supply, and therefore will be ineffective at stimulating the economy. Another potentially negative consequence is that quantitative easing generally causes a depreciation in the value of the home country’s currency. Depending on the country, this can be a negative. It is good for a country’s exports, but bad for imports, and can result in the country’s residents having to pay more money for imported goods.
Quantitative easing is considered an unconventional monetary policy, but it has been implemented a lot in recent times. Following the global financial crisis of 2007-08, the U.S. central bank, the Federal Reserve, implemented several rounds of quantitative easing. More recently, the Bank of Japan and the European Central Bank have implemented QE.