Quantitative easing explained

Quantitative easing, or QE, is a special form of monetary policy undertaken by central banks. It involves purchasing long-term government bonds and other financial assets, such as mortgage-backed securities (MBS), with the aim of injecting money into a struggling economy.

QE is usually employed when inflation is very low or negative, and traditional monetary policy becomes inefficient. Central banks buy financial assets from commercial banks and other financial institutions, which helps to increase the price of those assets to boost investment and lending.

Quantitative easing helps to grow the money supply by buying assets with newly created bank reserves, thus providing commercial banks with more liquidity. This differs from the traditional policy of buying and selling short-term government bonds to keep interest rates at a particular level.

How does quantitative easing work?

In implementing the policy of quantitative easing, central banks purchase government bonds and other securities. Large-scale purchases of government bonds lowers the interest rates or “yields” on those bonds. This helps to push down the interest rates offered on business loans and mortgages, making it cheaper for households and businesses to borrow money, encouraging spending, and thus stimulating the economy.

Quantitative easing can help to pull an economy out of recession. According to the IMF, the US Federal Reserve’s (Fed) quantitative easing undertaken after the global financial crisis in 2008 helped mitigate further economic damage.

In March 2020, as a response to the international economic shutdown driven by the Covid-19 pandemic, the Fed implemented a quantitative easing plan for more than $700bn (£544bn, €594bn). The programme was extended with the Fed’s commitment to buy $40bn in MBS and $80bn in Treasuries every month until further notification.

Although quantitative easing has proved to be an effective stimulus in a harsh economic environment, there are certain less-welcome outcomes to be considered. In increasing the money supply, central banks induce inflation. However, as central banks can’t force commercial banks to boost their lending activities or force borrowers to take loans, a quantitative easing policy may bring about inflation with no accompanying economic growth, which may further transform into stagflation.

Another potentially negative feature of quantitative easing is that it may devalue the country’s national currency. Although a devalued currency means that domestic manufacturers can export goods more competitively in the international market, it makes imports more expensive, which can increase production costs for businesses and prices for consumers.