What Is Quantitative Easing (QE), and How Does It Work?

Quantitative Easing (QE)

Investopedia / Mira Norian

What Is Quantitative Easing (QE)?

Quantitative easing (QE) is a form of monetary policy in which a central bank, like the U.S. Federal Reserve, purchases securities from the open market to reduce interest rates and increase the money supply.

Quantitative easing creates new bank reserves, providing banks with more liquidity and encouraging lending and investment. In the United States, the Federal Reserve implements QE policies.

Key Takeaways

  • Quantitative easing is a form of monetary policy used by central banks to increase the domestic money supply and spur economic activity.
  • In QE, the central bank purchases government bonds and other financial instruments, such as mortgage-backed securities (MBS).
  • Quantitive easing is typically implemented when interest rates are near zero and economic growth is stalled.
  • In the United States, the Federal Reserve implements quantitative easing policies.


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Understanding Quantitative Easing (QE)

Quantitive easing is often implemented when interest rates hover near zero and economic growth is stalled. Central banks have limited tools, like interest rate reduction, to influence economic growth. Without the ability to lower rates further, central banks must strategically increase the supply of money.

To execute quantitative easing, central banks buy government bonds and other securities, injecting bank reserves into the economy. Increasing the supply of money lowers interest rates further and provides liquidity to the banking system, allowing banks to lend with easier terms.

During the COVID-19 pandemic, quantitative easing was used and the Federal Reserve increased its holdings, accounting for 56% of the Treasury issuance of securities through the first quarter of 2021.

A government's fiscal policy may be implemented concurrently to expand the money supply. While the Federal Reserve can influence the supply of money in the economy, The U.S. Treasury Department can create new money and implement new tax policies with fiscal policy, sending money, directly or indirectly, into the economy. Quantitative easing can be a combination of both monetary and fiscal policy.

Does Quantitative Easing (QE) Work?

Most economists believe that the Federal Reserve's quantitative easing program helped to rescue the U.S. and global economy following the 2007-2008 financial crisis, however, the results of QE are difficult to quantify.

Globally, central banks have attempted to deploy quantitative easing as a means of preventing recession and deflation in their countries with similarly inconclusive results. While QE policy is effective at lowering interest rates and boosting the stock market, its broader impact on the economy isn’t apparent.

Commonly, the effects of quantitative easing benefit borrowers over savers and investors over non-investors, and there are pros and cons to QE, according to Stephen Williamson, a former economist with the Federal Reserve Bank of St. Louis.

Risks of Quantitative Easing (QE)

Inflation

As money is increased in an economy, the risk of inflation looms. As the liquidity works through the system, central banks remain vigilant, as the time lag between the increase in the money supply and the inflation rate is generally 12 to 18 months.

A quantitative easing strategy that does not spur intended economic growth but causes inflation can also create stagflation, a scenario where both the inflation rate and the unemployment rate are high.

Limited Lending

As liquidity increases for banks, a central bank like the Fed cannot force banks to increase lending activities nor can they force individuals and businesses to borrow and invest. This creates a “credit crunch,” where cash is held at banks or corporations hoard cash due to an uncertain business climate.

Devalued Currency

Quantitative easing may devalue the domestic currency as the money supply increases. While a devalued currency can help domestic manufacturers with exported goods cheaper in the global market, a falling currency value makes imports more expensive, increasing the cost of production and consumer price levels.

Real-World Examples of Quantitative Easing (QE)

United States

To combat the Great Recession, the U.S. Federal Reserve ran a quantitative easing program from 2009-2014. The Federal Reserve's balance sheet increased with bonds, mortgages, and other assets. U.S. bank reserves grew to over $4 trillion by 2017 providing liquidity to lend those reserves and stimulate overall economic growth. However, banks held $2.7 trillion in excess reserves, an unexpected outcome of the Federal Reserve's QE program.

In 2020, the Fed announced its plan to purchase $700 billion in assets as an emergency QE measure following the economic and market turmoil spurred by the COVID-19 shutdown. However, in 2022, the Federal Reserve dramatically shifted its monetary policy to include significant interest rate hikes and a reduction in the Fed’s asset holdings to sidetrack the persistent trend of higher inflation that emerged in 2021.

Europe and Asia

Following the Asian Financial Crisis of 1997, Japan fell into an economic recession. The Bank of Japan began an aggressive quantitative easing program to curb deflation and stimulate the economy, moving from buying Japanese government bonds to buying private debt and stocks. The quantitive easing campaign failed to meet its goals as the Japanese gross domestic product (GDP) fell from roughly $5.45 trillion to $4.52 trillion.

The Swiss National Bank (SNB) also employed a quantitative easing strategy following the 2008 financial crisis and the SNB owned assets that exceeded the annual economic output for the entire country. Although economic growth was spurred, it is unclear how much of the subsequent recovery can be attributed to the SNB's quantitative easing program.

In August 2016, the Bank of England (BoE) launched a quantitative easing program to help address the potential economic ramifications of Brexit. By buying 60 billion pounds of government bonds and 10 billion pounds in corporate debt, the plan was intended to keep interest rates from rising and stimulate business investment and employment.

By June 2018, the Office for National Statistics in the U.K. reported that gross fixed capital formation was growing at an average quarterly rate of 0.4%, lower than the average rate from 2009 through 2018. U.K. economists were unable to determine whether or not growth would have been evident without this quantitative easing program.

How Does Quantitative Easing Work?

Quantitative easing is a type of monetary policy in which a nation’s central bank tries to increase the liquidity in its financial system, typically by purchasing long term government bonds from that nation’s largest banks and stimulating economic growth by encouraging banks to lend or invest more freely.

Is Quantitative Easing Printing Money?

Critics have argued that quantitative easing is effectively a form of money printing and point to examples in history where money printing has led to hyperinflation. However, proponents of quantitative easing claim that banks act as intermediaries rather than placing cash directly in the hands of individuals and businesses so quantitative easing carries less risk of producing runaway inflation.

How Does Quantitative Easing Increase Bank Lending?

QE replaces bonds in the banking system with cash, effectively increasing the money supply, and making it easier for banks to free up capital, so they can underwrite more loans and buy other assets. A bank can lend any deposits above its 10% in reserve.

The Bottom Line

Quantitative easing is a form of monetary policy in which a central bank, like the U.S. Federal Reserve, purchases securities through open market operations to increase the supply of money and encourage bank lending and investment. QE policies have been implemented globally, however, their impact on a country's economy is often debated.

Article Sources
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  1. Brookings Institute. "Lessons Learned From Monetary and Fiscal Policy During COVID-19."

  2. Forbes. "What Is Quantitative Easing? How Does QE Work?"

  3. Business Insider. "From Quantitative Easing to Stagflation."

  4. Federal Reserve Bank of St. Louis. "Quantitative Easing: How Well Does This Tool Work?"

  5. U.S. Bank. "Federal Reserve Concludes Tapering as It Recalibrates Monetary Policy to Fight Inflation."

  6. International Monetary Fund. "The Asian Crisis, the IMF, and the Japanese Economy."

  7. The World Bank. "GDP (Current US$) - Japan."

  8. Swiss Society of Economics and Statistics. "Ten Years' Experience with the Swiss National Bank's Monetary Policy Strategy," Pages 52-57.

  9. The World Bank. "GDP (Current US$) - Switzerland."

  10. Bank of England. "Bank Rate Cut and Other New Measures: What Do They Mean?"

  11. Office for National Statistics. "Gross Fixed Capital Formation: Business Investment: CVM SA: £m, % Change, Latest Quarter on Previous Quarter."

  12. U.S. Federal Reserve Bank. "Reserve Requirements."

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