Quantitative easing (QE)

DEFINITION of Quantitative easing (QE)

Quantitative easing (QE) is a massive expansion of the open market operations of a central bank. It’s useful to stimulate the economy by making it easier for businesses to borrow money. 

WHAT IT IS IN ESSENCE

Quantitative easing (or QE), is also known as large-scale asset purchases.

It is the act of increasing the amount of money in a country’s economy by that country’s central bank.

In order for a central bank to increase the money supply, new money must be created and introduced into the economy.

A monetary policy of quantitative easing outlines the process by which the central bank will increase the money supply. Usually, central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply. That’s why this an unconventional monetary policy.

HOW TO USE

Usually to stimulate an economy when conventional forms of monetary policy are no longer effective. For example when interest rates are at or near zero.

It was the case, for instance, after the 2008 financial crash and following recession.

The theory behind QE is to flood the market with money and low-interest rates should encourage banks to lend. That have to encourage consumers and businesses to spend. Sash is a low-yielding asset.

So, investors will look to purchase other assets such as equities or private sector debt to gain higher rates of return.

Central banks which go through QE have a difficult balancing act. Because increasing the money supply is too rapidly, it can lead to untenable increases in inflation.

Quantitative easing also stimulates the economy in another way.

The federal government auctions off large quantities of Treasurys to pay for the expansionary fiscal policy.

As the Fed buys Treasuries, it increases demand, keeping Treasury yields low. Since Treasurys are the basis for all long-term interest rates.  It also keeps auto, furniture, and other consumer debt rates affordable.

The same is true for corporate bonds, making it cheaper for businesses to expand.

Most important, it keeps long-term, fixed-interest mortgage rates low.