Quantitative easing why

In the United States, only the Federal Reserve has this unique power. That's why some people say the Federal Reserve is printing money. In buying up securities from its member banks, the Federal Reserve gives them cash in exchange for assets like bonds. The extra cash can then be lent out. The fed also controls the banks' reserve requirement, which is how much of their funds they're required to keep on hand compared to what they lend out.

Lowering the reserve lets the banks lend out more of their money. More money going out increases the supply of money, which allows interest rates to fall. Lower rates are an incentive for people to borrow and spend, which stimulates the economy. A bank lends any deposits above its reserves. These loans then get deposited in other banks. The Fed used quantitative easing in the wake of the financial crisis to restore stability to financial markets.

Quantitative easing stimulates the economy in three other ways. The federal government auctions off large quantities of Treasurys to pay for expansionary fiscal policy. As the Fed buys Treasurys, it increases demand, keeping Treasury yields low with bonds, there is an inverse relationship between yields and prices. Treasurys are the basis for all long-term interest rates.

Therefore, quantitative easing through buying Treasurys also keeps auto, furniture, and other consumer debt rates affordable. The same is true for long-term, fixed-interest debt. When mortgage rates are kept low, it supports the housing market. And low rates on corporate bonds makes it affordable for businesses to expand. Increasing the money supply also keeps the value of the country's currency low.

When the dollar is weaker, U. It also makes exports less expensive. The only downside is that QE increases the Fed's holdings of Treasurys and other securities. Some experts worry that QE could create inflation or even hyperinflation. The more dollars the Fed creates, the less valuable existing dollars are. Over time, this lowers the value of all dollars, which then buys less.

The result is inflation. But inflation doesn't occur until the economy is thriving. Once that happens, the assets on the Fed's books increase as well. The Fed would have no problem selling them. Selling assets would reduce the money supply and cool off any inflation. Japan was the first country to use QE from to It restarted in with the election of Shinzo Abe as Prime Minister.

It agreed to purchase 60 billion in euro-denominated bonds, lowering the value of the euro and increasing exports. It increased those purchases to 80 billion euros a month. In December , it announced it would taper its purchases to 60 billion euros a month in April In December , it ended the program.

In , the Fed launched four rounds of QE to fight the financial crisis. They lasted from December to October The Fed resorted to QE because its other expansionary monetary policy tools had reached their limits. The fed funds rate and the discount rate were zero. The Fed even began paying interest to banks for their reserve requirements. As a result, quantitative easing became the central bank's primary tool to stop the crisis.

Until , it was the largest expansion from any economic stimulus program in history. At the Nov. Treasury notes, and mortgage-backed securities MBS from member banks. List of Partners vendors. Quantitative easing QE is a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment.

Buying these securities adds new money to the economy, and also serves to lower interest rates by bidding up fixed-income securities. It also expands the central bank's balance sheet. When short-term interest rates are either at or approaching zero, the normal open market operations of a central bank, which target interest rates, are no longer effective.

Instead, a central bank can target specified amounts of assets to purchase. Quantitative easing increases the money supply by purchasing assets with newly-created bank reserves in order to provide banks with more liquidity. To execute quantitative easing, central banks increase the supply of money by buying government bonds and other securities. Increasing the supply of money lowers interest rates. When interest rates are lower, banks can lend with easier terms.

Quantitive easing is typically implemented when interest rates are already near zero, because, at this point, central banks have fewer tools to influence economic growth. If quantitative easing itself loses effectiveness, a government's fiscal policy may also be used to further expand the money supply. As a method, quantitative easing can be a combination of both monetary and fiscal policy; for example, if a government purchases assets that consist of long-term government bonds that are being issued in order to finance counter-cyclical deficit spending.

If central banks increase the money supply, it can create inflation. The worst possible scenario for a central bank is that its quantitative easing strategy may cause inflation without the intended economic growth. An economic situation where there is inflation, but no economic growth, is called stagflation. Although most central banks are created by their countries' governments and have some regulatory oversight, they cannot force banks in their country to increase their lending activities.

Similarly, central banks cannot force borrowers to seek loans and invest. If the increased money supply created by quantitive easing does not work its way through the banks and into the economy, quantitative easing may not be effective except as a tool to facilitate deficit spending. Another potentially negative consequence of quantitative easing is that it can devalue the domestic currency.

While a devalued currency can help domestic manufacturers because exported goods are cheaper in the global market and this may help stimulate growth , a falling currency value makes imports more expensive. This can increase the cost of production and consumer price levels. From until , the U. Federal Reserve ran a quantitative easing program by increasing the money supply. This had the effect of increasing the asset side of the Federal Reserve's balance sheet , as it purchased bonds, mortgages, and other assets.

The Federal Reserve's liabilities, primarily at U. The goal of this program was for banks to lend and invest those reserves in order to stimulate overall economic growth. However, what actually happened was that banks held onto much of that money as excess reserves. At its pre-coronavirus peak, U. Most economists believe that the Federal Reserve's quantitative easing program helped to rescue the U.

However, the magnitude of its role in the subsequent recovery is actually impossible to quantify. Other central banks have attempted to deploy quantitative easing as a means of fighting off recession and deflation in their countries with similarly inconclusive results. Following the Asian Financial Crisis of , Japan fell into an economic recession. Beginning in , the Bank of Japan BoJ —Japan's central bank—began an aggressive quantitative easing program in order to curb deflation and stimulate the economy.

The Bank of Japan moved from buying Japanese government bonds to buying private debt and stocks. However, the quantitive easing campaign failed to meet its goals.

Eventually, the SNB owned assets that exceeded the annual economic output for the entire country. Although economic growth has been positive in Switzerland, it is unclear how much of the subsequent recovery can be attributed to the SNB's quantitative easing program.

In August , the Bank of England BoE announced that it would launch an additional quantitative easing program to help address any potential economic ramifications of Brexit.

The plan was for the BoE to buy 60 billion pounds of government bonds and 10 billion pounds in corporate debt. The plan was intended to keep interest rates from rising in the U. The fact that at the same time the Bank of England is buying hundreds of billions of pounds' worth of bonds helps the government to raise that money.

The Bank doesn't buy directly from the government, it buys from other investors, but its actions undoubtedly make government borrowing cheaper and easier. When the latest round of QE is complete, the Bank of England will hold well over a third of the national debt. The government also pays much less interest on bonds owned by the Bank of England than other investors - which takes further pressure off the public finances.

Most research suggests that QE helped to keep economic growth stronger, wages higher, and unemployment lower than they would otherwise have been. As well as bonds, it increases the prices of things such as shares and property.

This tends to benefit wealthier members of society who already own these things, as the Bank itself concluded in Meanwhile, younger people found it harder to buy their first homes and build up savings.

Another important side effect of QE hit pension funds. Government bond prices are used to estimate how much it will cost to provide pensions in the future. If those bond prices go up, the cost of providing future pensions rises. As a result many firms were obliged to make bigger payments into their pension schemes, reducing money available to invest elsewhere.

And in many cases, QE will have contributed to the decision to close pension schemes altogether. Image source, AFP. Quantitative easing aims to support the economy by encouraging people to save less and spend a bit more.

What is quantitative easing meant to do? What does the governor of the Bank of England do? Image source, Getty Images.