Quantitative Easing

Quantitative Easing

What is quantitative easing?

Quantitative Easing (QE) is a monetary policy strategy used by central banks. It refers to the situation when a central bank buys securities in an attempt to lower interest rates, increase the money supply and lending to consumers and businesses. The goal is to stimulate economic activity during the financial crisis and keep credit flowing.

Quantitative Easing understanding

When a central bank decides to use quantitative easing, it makes large-scale purchases of financial assets such as government and corporate bonds and even stocks. This relatively simple solution has powerful results: the amount of money circulating in the economy increases, which helps lower long-term interest rates. This reduces the cost of borrowing, which stimulates economic growth.

When the Federal Reserve adjusts its target for the federal funds rate, it tries to influence the short-term rates that banks charge each other for overnight loans. The Fed has used interest rate policy for decades to keep credit flowing and the US economy on track.

When the federal funds rate was cut to zero during the Great Recession, further rate cuts to encourage lending became impossible. Instead, the Fed rolled out quantitative easing and began buying mortgage-backed securities (MBS) and Treasuries to prevent a freeze in the economy.

QE in the United States

In 2008, the Fed launched four rounds of quantitative easing to combat the financial crisis. They lasted from December 2008 to October 2014. The Fed resorted to quantitative easing because its other expansionary monetary policy tools reached their limit. The federal funds rate and the discount rate were zero. The Fed had even begun paying interest to banks on their reserve requirements. As a result, QE has become the central bank's main tool for stopping the crisis.

Quantitative easing increased the money supply and the Fed's balance sheet by nearly $4 trillion. Until 2020, this was the largest expansion of any economic stimulus program in history. The Fed's balance sheet doubled from less than $1 trillion in November 2008 to $4.4 trillion in October 2014.

Cons of Quantitative Easing

The impact of QE is not always beneficial for everything in the economy. Let’s look through some of the potential dangers that can occur.

The biggest danger of QE is the risk of inflation. When the central bank prints money, the supply of dollars increases. Hypothetically, this could lead to a decrease in the purchasing power of money already in circulation. An increase in the money supply allows people and businesses to increase their demand for the same amount of resources, leading to higher prices, potentially to an unsustainable degree.

The next thing that some critics doubt about the effectiveness of quantitative easing, especially about stimulating the economy and its uneven impact on different people. QE could spark a stock market boom, and stock ownership is concentrated among Americans who are already well off, no matter if it’s a crisis or not. By easing interest rates, the Fed encourages speculative activity in the stock market, which can cause bubbles as long as the Fed sticks to its policies.

The final danger of QE is that it could exacerbate income inequality due to its impact on both financial assets and real assets such as real estate. The central bank doesn’t have the infrastructure to lend directly to consumers effectively, so it uses banks as intermediaries for lending. Once QE money is on the balance sheets of primary dealers, it may not benefit everyone in the economy as intended.

Despite all these drawbacks, specialists believe that QE has proven to be "extremely effective" in stabilizing and eventually boosting asset prices in both the equity and stock market.

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2022-06-06 • Updated

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