What is Quantitative Easing?
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Quantitative Easing Explained
The Quantitative Easing definition, commonly referred to as QE, is an unconventional monetary policy tool of central banks where the central bank buys securities from the open market to inject cash into the economy.
Increasing the cash supply encourages banks to lend and potential borrowers to borrow.
How Does Quantitative Easing Work?
The central bank’s monetary tools often focus on adjusting interest rates.
Lower interest rates are expansionary because they lower the cost of money and encourage economic growth, and higher interest rates are contractionary because they increase the cost of money and slow growth.
Central banks use quantitative easing after they’ve exhausted conventional tools, such as lowering the interest rate.
For example, after announcing a new interest rate target of 0 to 0.25%, on March 15, 2020, the Federal Reserve announced a $700 billion quantitative easing program. $500 billion of Treasury securities and $200 billion of mortgage-backed securities.
Is There a Shortcoming with QE?
Quantitative easing has the following shortcomings:
1.) While QE puts money into the hands of investors, it does not force them to spend it.
For example, in the 2009 financial crisis, the US Federal Reserve bought $4 trillion in securities from banks, but because of the poor economic outlook, banks mostly held the extra cash in reserves instead of putting it back into the economy.
2.) More cash in the market increases inflationary pressure and devalues a currency against its global peers.
Inflation without economic growth is known as stagflation.
3.) The central bank’s large-scale purchasing of securities often results in a country’s national debt growing substantially.