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What is Quantitative Easing?
Quantitative Easing (QE) is an expansion of the Open Market Operations of the Central Bank. It is an expansionary monetary policy whereby Central bank purchases predetermined amounts of Government bonds or other financial assets for stimulating the economy. This technique is generally implemented when the Standard monetary policy has become ineffective in tackling low inflationary or deflationary situations.
Process of Quantitative Easing
This quantitative easing involves the Central bank buying securities (Government bonds) from its member banks for adding liquidity to Capital/Secondary markets. Simultaneously, the Central bank issues a credit to the Reserves of the bank to buy the securities. It offers the same effect as that of increasing the money supply. The purpose of such a monetary policy measure is:
- Lower interest rates and enhance the prospects of economic growth.
- Drop in rates of interest allows the banks to disburse more loans and stimulating demand by giving money to businesses for expansion.
- Quantitative Easing helps in maintaining the value of the country’s currency at a lower level. This in turn makes the stock of the country more attractive to the foreign investors
- The exports also become cheaper.
One should note that this method will not be useful if the short-term interest rates are zero or approaching those levels. In such a case, the assets with long-term maturity shall be purchased since it reduces the long-term interest rates on the yield curve. Quantitative Easing can guard in inflation falling below a specified level. The process can expose to certain risks such as are:
- If the amount of quantitative easing is overestimated or too much of money supply is released in the economy, then the level of inflation expected to be achieved could be breached creating excessive inflation.
- Less effective if banks remain reluctant to lend to potential borrowers or other stringent regulations which prevent in enhancing money supply.
Japan’s Quantitative Easing Timeline
This policy was first used by the Bank of Japan (BOJ) for combatting deflation in 2000-01. An interest rate of close to zero was maintained since 1999 and it was in March 2001 that the BOJ flooded commercial banks with excess liquidity for enhancing lending facilities, thereby splurging stock of excess reserves. The objective was to reduce any shortage of liquidity.
BOJ achieved this by purchasing more Government bonds than required and bringing the interest rates to the level of Zero. It extended the terms of Commercial Paper purchasing operation and purchased Equities and ABS (asset-backed securities)
- From a statistical perspective, over a time span of 4 years, the current account balance of commercial banks was increased from ¥5 trillion to ¥35 trillion (approximately US$300 billion). BOJ also enhanced the quantity of long-term Japanese Government bonds by three times which it could buy on a monthly basis.
- In 2011, BOJ increased this current account balance from ¥40 trillion (US$504 billion) to ¥50 trillion (US$630 billion). Further expansion of its asset purchase program was executed by ¥5 trillion ($66bn) to a total of ¥55 trillion.
- In 2013, the Bank of Japan intended expansion of its asset purchase program by 60 to 70 trillion Yen a year. The Bank was expecting to bring Japan from deflation to inflation, aiming for 2% inflation aiming to double the money supply.
- On 31 October 2014, BOJ announced the expansion of its bond-buying program, to now buy 80 trillion Yen of bonds a year.
US Quantitative Easing Timeline
During the peak of the financial crisis in 2008, the US Federal Reserve was required to take urgent steps which involved dramatically expanding Balance Sheet by addition of new assets and liabilities. The Quantitative Easing was split up in multiple phases with QE1 involving:
- The U.S. Federal Reserve held around $700-$800 billion of Treasury notes on its Balance Sheet prior to the Recession.
- November 2008 witnessed the Fed buying $600 million in MBS (Mortgage Backed Securities)
- In March 2009, the Fed held $1.75 trillion of bank debt, MBS and Treasury notes which peaked to $2.1 trillion in June 2010.
- The condition of the economy had to be monitored constantly and in November 2010, the Fed announced QE2 involving $600 billion of Treasury securities purchased till the end of Q2 2011.
- The third round of Quantitative Easing was announced called as “QE3” in September 2012 in which $40 billion per month, open-ended bond purchasing Quantitative Easing programme of Agency MBS was executed. Additionally, it was announced that it would maintain the Federal Funds rate nearby zero through 2015. Since it was open-ended in nature, it was popularly referred to as “Quantitative Easing Infinity”
In 2013, when it seemed the economy was bottoming out, there were intentions of ‘tapering’ some of the Fed’s Quantitative Easing policies depending on the economic data. There were no reductions in the amount of bond purchases but the buying Quantitative Easing (QE) programme was expected to be stopped by mid-2014.
Fed did not announce any interest rates hike but suggested if inflation target of 2% and an unemployment rate of 6.5% be achieved, an increase in interest rate shall be considered. In the second half of 2013, the Fed continued with its Quantitative Easing programme and decided to reduce at a future date. It was in the last quarter of 2014, these purchases were stopped after an accumulation of $4.5 trillion in assets.
The Quantitative Easing (QE) programme likely contributed to the following:
- Lower Interest rates for Corporate Bonds and Mortgage rates and thus aiding support prices
- Higher stock market valuation (Higher P/E Ratio in the S&P 500 index)
- Increased rate of inflation and stable expectations for the future
- The higher rate of Job creation
- A higher rate of GDP growth
ECB Quantitative Easing Timeline
In 2009, when the crisis was surfacing, the European Central Bank (ECB) would be focussing on buying covered bonds signaling its initial purchases would be around €60 billion.
Subsequently, in 2013 the Swiss National Bank held one of the largest Balance Sheet equivalent to the size of the economy of Switzerland. The ECB’s assets were around 30% of the GDP. One of the massive changes in policies of 2015 was termed as ‘Expanded asset purchase programme’ which involved a purchase of €60 billion from central governments, agencies and European institutions would be bought on a monthly basis.
The Quantitative Easing lasted until September 2016 with a total Quantitative Easing of €1.1 trillion.
This has been a guide on what is Quantitative Easing (QE). Here we discuss its definition along with examples from Japan, US, UK, ECB and process of Quantitative Easing. You may have a look at these below articles for further learnings –
- List of Financial Assets Examples
- Advantages of Financial Assets
- Examples of Account Balance
- Differences Between Asset Purchase vs Stock Purchase
- How to Become a Quantitative Financial Analyst
- Callable Bonds
- The Top 10 Economic Indicators
- What is Macroeconomics?
- Macroeconomics vs Microeconomics
- What is Money Market?