What Is Quantitative Easing (QE)?
Quantitative easing (QE) is a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment. Buying these securities adds new money to the economy, and also serves to lower interest rates by bidding up fixed-income securities. It also expands the central bank's balance sheet.
When short-term interest rates are either at or approaching zero, the normal open market operations of a central bank, which target interest rates, are no longer effective. Instead, a central bank can target specified amounts of assets to purchase. Quantitative easing increases the money supply by purchasing assets with newly-created bank reserves in order to provide banks with more liquidity.
- Quantitative easing (QE) is a form of monetary policy used by central banks as a method of quickly increasing the domestic money supply and spurring economic activity.
- Quantitative easing usually involves a country's central bank purchasing longer-term government bonds, as well as other types of assets, such as mortgage-backed securities (MBS).
- In response to the economic shutdown caused by the COVID-19 pandemic, on March 15, 2020, the U.S. Federal Reserve announced a quantitative easing program that amounted to over $700 billion.
Understanding Quantitative Easing
To execute quantitative easing, central banks increase the supply of money by buying government bonds and other securities. Increasing the supply of money lowers the cost of money—the same effect as increasing the supply of any other asset in the market. A lower cost of money leads to lower interest rates. When interest rates are lower, banks can lend with easier terms. Quantitive easy is typically implemented when interest rates are approaching zero because, at this point, central banks have fewer tools to influence economic growth.
If quantitative easing itself loses effectiveness, a government's fiscal policy may also be used to further expand the money supply. As a method, quantitative easing can be a combination of both monetary and fiscal policy; for example, if a government purchases assets that consist of long-term government bonds that are being issued in order to finance counter-cyclical deficit spending.
If central banks increase the money supply, it can create inflation. The worst possible scenario for a central bank is that its quantitative easing strategy may cause inflation without the intended economic growth. An economic situation where there is inflation, but no economic growth, is called stagflation.
Although most central banks are created by their countries' governments and have some regulatory oversight, they cannot force banks in their country to increase their lending activities. Similarly, central banks cannot force borrowers to seek loans and invest. If the increased money supply created by quantitive easing does not work its way through the banks and into the economy, quantitative easing may not be effective (except as a tool to facilitate deficit spending).
Another potentially negative consequence of quantitative easing is that it can devalue the domestic currency. While a devalued currency can help domestic manufacturers because exported goods are cheaper in the global market (and this may help stimulate growth), a falling currency value makes imports more expensive. This can increase the cost of production and consumer price levels.
Starting in 2008, the U.S. Federal Reserve started a quantitative easing program by increasing the money supply by $4 trillion. This had the effect of increasing the asset side of the Federal Reserve's balance sheet, as it purchased bonds, mortgages, and other assets. The Federal Reserve's liabilities, primarily at U.S. banks, grew by the same amount. The goal of this program was for banks to lend and invest those reserves in order to stimulate overall economic growth.
However, what actually happened was that banks held onto much of that money as excess reserves. At its peak, U.S. banks held $2.7 trillion in excess reserves, which was an unexpected outcome of the Federal Reserve's quantitative easing program.
Most economists believe that the Federal Reserve's quantitative easing program helped to rescue the U.S. (and potentially the world) economy following the 2008 financial crisis. However, the magnitude of its role in the subsequent recovery is actually impossible to quantify. Other central banks have attempted to deploy quantitative easing as a means of fighting off recession and deflation in their countries with similarly inconclusive results.
Example of Quantitive Easing
Following the Asian Financial Crisis of 1997, Japan fell into an economic recession. Beginning in 2000, the Bank of Japan (BoJ)–Japan's central bank–began an aggressive quantitative easing program in order to curb deflation and to stimulate the economy. The Bank of Japan moved from buying Japanese government bonds to buying private debt and stocks. However, the quantitive easing campaign failed to meet its goals. Between 1995 and 2007, the Japanese gross domestic product (GDP) fell from $5.45 trillion to $4.52 trillion in nominal terms, despite the Bank of Japan's efforts.
The Swiss National Bank (SNB) also employed a quantitative easing strategy following the 2008 financial crisis. Eventually, the SNB owned assets that were nearly equal to the annual economic output for the entire country. This made the SNB's version of quantitive easing the largest in the world (as a ratio to a country's GDP). Although economic growth has been positive in Switzerland, it is unclear how much of the subsequent recovery can be attributed to the SNB's quantitative easing program. For example, although interest rates were pushed below 0%, the SNB was still unable to achieve its inflation targets.
In August 2016, the Bank of England (BoE) announced that it would launch an additional quantitative easing program to help address any potential economic ramifications of Brexit. The plan was for the BoE to buy 60 billion pounds of government bonds and 10 billion pounds in corporate debt. The plan was intended to keep interest rates from rising in the U.K. and also to stimulate business investment and employment.
From August 2016 through June 2018, the Office for National Statistics in the U.K. reported that gross fixed capital formation (a measure of business investment) was growing at an average quarterly rate of 0.4 percent. This was lower than the average rate from 2009 through 2018. As a result, economists have been tasked with trying to determine whether or not growth would have been worse without this quantitative easing program.
On March 12, 2020, the U.S. Federal Reserve announced its plan to implement up to $1.5 trillion in asset purchases as an emergency measure to provide liquidity to the U.S. financial system. This decision was made as a result of the massive economic and market turmoil brought on by the rapid spread of the COVID-19 virus and the ensuing economic shutdown.