What Is Quantitative Easing?
Quantitative easing (QE) is a monetary policy which a central bank may turn to in times of economic crisis to inject more money into circulation. The Bank of Japan was the first to adopt this type of policy as a means of injecting “new money” into the economy, thereby “easing” the (low) quantity and expanding the central bank’s balance sheet.
To implement QE, a country’s central bank will engage buying assets in the money market such as bonds, and other securities from commercial banks to introduce more money into circulation. This typically works when short-term interest rates are at zero or near zero and consumers aren’t investing. Quantitative easing can encourage individuals and businesses to borrow from banks, which will be able to dole out easy, low-interest loans with their excess monetary reserves which can in turn boost a country’s economic growth.
How Does Quantitative Easing Work?
Quantitative easing involves a central bank—like the Federal Reserve System (commonly called the Fed in the United States) or the Central Bank of Nigeria —buying assets from a private financial institution or lender. These assets may include mortgage-backed securities, government bonds, corporate bonds, treasury bills, or other long-term securities. When the central bank purchase these securities on behalf of the Federal government, it releases money to increase the financial reserves of the commercial banks.
This enables banks to have more money offer low interest rates credit facilities to private individuals and companies in order to entice them to invest in areas like the housing market and stock market. Hence, money that was once in the government’s reserves is now in circulation, without the central bank literally printing more money that is not backed up by assets. This is how quantitative easing can theoretically stimulate a country’s economy, if well implemented.
Advantages and Disadvantages of Quantitative Easing (QE)
Quantitative easing is a complex macroeconomic policy that has several potential advantages and disadvantages.
Advantages of Quantitative Easing
Quantitative easing is an uncommon monetary policy that a central bank will adopt in the face of widespread economic crisis. It is considered by some economists as quick strategy of stimulating a country’s economy in times of dire economic hardship.
Some of the advantages of QE include:
- Low-risk lending for banks
- Encourages spending
- Boost assets prices
1 Low-risk lending for banks
Quantitative easing policy can typically only work in an economy where interest rates have declined to zero percent or near zero percent. Commercial banks having more money in their reserves in the face of these lower interest rates reduces the risks of banks giving loans to civilians.
2 Encourages people to spend
The purpose of QE is to level out markets to make spending and investing money more appealing and accessible to consumers. Lower interest rates can increase the likelihood that business and civilian borrowers will take out loans to make purchases, thereby boosting economic activity.
3 Boosts the prices of assets
When the government participates in bond-buying during a QE measure, they replace the bonds with money that the previous bond-holder can reinvest in other assets in different financial markets, increasing their value.
Disadvantages of Quantitative Easing
Quantitative easing is a large-scale emergency measure that focuses on short-term economic growth, which can occur at the expense of a financial system’s long-term stability.
Here are some of the potential cons of QE
- Can cause inflation
- Can cause stagflation
- Reduces value of country's currency
1 Can cause inflation
Adding currency into circulation can be tantamount to creating money out of thin air, which can contribute to inflation and lower bond yields. Inflation is the steady increase in the price of goods and services over time. It devalues units of currency resulting in consequences like a higher cost of living.
2 Can cause stagflation
Stagflation refers to a rise in the cost of goods and living without yielding sufficient economic growth. When the central bank purchases financial assets, they are doing so to make it easier for others to make investments. However, during a great recession or global financial crisis, people are less likely to spend money, so there is no guarantee that the method will work.
3 Impacts the value of a nation’s currency.
Unless other countries are also taking quantitative easing measures, QE can drastically reduce the value of a country’s national currency. This is indicative of a decline in the international purchasing power—or the number of goods that one unit of currency can buy—of a country’s national currency.