Quantitative easing (QE) - What is quantitative easing?
Quantitative easing is an unconventional type of monetary policy implemented by regulatory authorities that affects economic growth and inflation
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Traditional monetary policy follows either expansionary or contractionary types, depending on what is needed in the economy. Quantitative Easing (QE) is a type of monetary policy wherein a central bank generates funds in order to buy or sell securities (most commonly, government securities) causing interest rates to decrease.
Why use QE?
The results of QE include an increase in money supply, thanks to the extra funds entering the market through the financial institutions. Unlike printing new bank notes, QE impacts the economy in an arguably more controlled way, by lowering interest rates for improved lending conditions instead of flooding the market with cash.
However, QE must be balanced perfectly in order to prevent possible side effects - or the negative impacts of the policy. Side effects of QE include an increase in prices for consumers, which can also encourage increased buying before the prices go up.
The use of QE is controversial, as it has produced mixed (or rather debatable) results over the years in several instances around the world.
The negative side of QE
When the market becomes too flooded with money, it can lead to inflation. The use of any monetary policy, is therefore, a balancing act. It can also lead to something called ‘stagflation’ which is inflation without any accompanying economic growth.
While QE can have a positive impact on the economy, it is not designed to be used over the long-term. It can affect the currency of the country in which it is implemented - potentially devaluing it, making imports more expensive and thereby also driving up the cost of production as well as consumer prices.
QE also relies on the banks that are involved in the transactions of government securities with the central bank. The funds that are injected into these banks are expected to matriculate down through the economy through lending and improve conditions. However, the central bank does not control these banks and this can lead to some unintended side effects (see the U.S. example below).
Quantitative easing in use
A more recent approach to dealing with a recession, quantitative easing was famously implemented to aid in the 2008 financial crisis in the U.S. In this initiative, the U.S. Federal Reserve increased the money supply through QE (multiple rounds of QE) by $4 trillion by buying up bonds and mortgages, among other assets.
The use of QE is largely credited with helping to turn the U.S. economy around and bring it out of recession. However, some unexpected side effects occurred that blur that finding, including the banks holding on to approximately $2.7 trillion in excess reserves, which means that this money did not find its way into the U.S. economy.
Japan has also used QE. In 1997, Japan experienced a recession due to the Asia Economic Crisis. The Bank of Japan initiated QE by buying bonds and then buying stocks and private debt at an attempt to turn the economy around. However, it became clear that in this instance, QE was not effective in rebooting the economy, as it continued to fall by almost $1 trillion over the next seven years.