Quantitative Easing

Updated on April 16, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What is Quantitative Easing?

Quantitative easing (QE) is an advanced monetary policy of central banks to stimulate growth in a stagnant economy by large scale buying of government bonds and other assets. QE attempts to influence an economy by issuing more money to enhance the money supply. It does not involve printing more cash. Instead, the central bank creates new money by purchasing securities electronically and updating the transactions in its balance sheet.

The measure comes as an alternative to revive investment, consumption and prices when standard monetary policies have failed to increase growth.

Key Takeaways

  • Quantitative easing is a corrective measure of country’s central bank to induce new money in its slowed economy by bulk purchases of government or corporate securities from the open market.
  • Quantitative easing aims at economic stability and growth during financial crisis with the idea that boosting the money supply will increase consumers’ buying power, investments and productivity. It will pass on the growth spur to aggregate demand, prices, wages, and employment – putting an end to deflation.
  • The reversal of a Quantitative easing program at the right time is equally important to avoid the adverse effects like hyperinflation or stagflation.

Quantitative Easing Explained 

What is Quantitative Easing

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Quantitative easing is an aggressive monetary policyMonetary PolicyMonetary policy refers to the steps taken by a country’s central bank to control the money supply for economic stability. For example, policymakers manipulate money circulation for increasing employment, GDP, price stability by using tools such as interest rates, reserves, bonds, etc.read more of central banks such as the Federal Reserve adopted during an economic crisis like the Great DepressionGreat DepressionThe Great Depression refers to the long-standing financial crisis in the history of the modern world. It began in the United States on October 29, 1929, with the Wall Street Crash and lasted till 1939.read more. Normally, central banks influence inter-bank overnight lending interest rates to increase or decrease the money supply in the economy.

A decrease in overnight lending rate eventually decreases overall borrowing rates in the economy, which helps consumers borrow more. With more money in hand, consumption, demand and business improve, gradually putting the economy back on track. However, lowering the interest rates to zero cannot force banks to lower borrowing rates if they aren’t willingly which counters the policy. Resultantly, to increase the money supply, central banks switch to quantitative easing policies which do not involve printing new banknotes.

Instead, the central bank creates new money by electronically buying government bonds and other assets from the open market. The central bank’s balance sheet records this transaction, throwing light on the virtually added money. As part of its quantitative easing measures, the Fed had decided to indefinitely buy $120 billion bonds each month in March 2020. It was to help the economy recover after being battered with Covid-19.

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How does Quantitative Easing Affect an Economy?

The idea of Quantitative easing is that when the central bank bulk buys government bonds and some long-term securities from the financial marketFinancial MarketThe term "financial market" refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces.read more, it increases their demand. As a result, bond pricesBond PricesThe bond pricing formula calculates the present value of the probable future cash flows, which include coupon payments and the par value, which is the redemption amount at maturity. The yield to maturity (YTM) refers to the rate of interest used to discount future cash flows.read more climb up with high demand, lowering their yields as bond price and yield have an inverse relationship.

Due to low returns, investors start switching to other securities in the capital marketCapital MarketA capital market is a place where buyers and sellers interact and trade financial securities such as debentures, stocks, debt instruments, bonds, and derivative instruments such as futures, options, swaps, and exchange-traded funds (ETFs). There are two kinds of markets: primary markets and secondary markets.read more for higher earnings. Resultantly, stock market investment goes up with booming stock prices. In 2020, S&P 500 fell by over 30% from its record highs due to the pandemic. But, with the help of the US government’s stimulus and other elements, it rose over 70% from March falls. In fact, the stock market turned bullish after a few months.

Additionally, buying assets from other banks increases their reserve balance tremendously. The availability of money with banks increases, enabling them to lower rates to induce borrowings. With ease in borrowing, investment increases. Governments also add to this by introducing fiscal policies such as the US’s government signing a $1.3 trillion Covid relief stimulus. It involves direct lending to most Americans worth $1400.

With more money circulating, borrowing rates fall further. People save less as they earn less on their savings and bank accounts, so they spend more. Therefore, if Quantitative easing measures work, they can increase the aggregate demandAggregate DemandAggregate Demand is the overall demand for all the goods and the services in a country and is expressed as the total amount of money which is exchanged for such goods and services. It is a relationship between all the things which are bought within the country with their prices.read more and prices. When businesses earn more, they produce and hire more. With improved GDPGDPGDP or gross domestic product refers to the sum of the total monetary value of all finished goods and services produced within the border limits of any country. GDP determines the economic health of a nation. GDP = C + I + G + NXread more and employment rates, the economic growth revives.

Quantitative Easing Examples

When we talk about quantitative easing in economics, United States, Europe and Japan get an obvious mention. For example, during the 2009 financial crisisFinancial CrisisThe term "financial crisis" refers to a situation in which the market's key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors.read more, the Bank of England purchased 200 billion pounds bonds as part of QE and has relied upon the measure many times. In 2020, it bought 895 billion pounds of bonds in response to the pandemic slowdown.

Over the years, emerging economies such as Philippines, Indonesia, South Africa, etc., have also adopted the QE methodology for economic well-being. Let us take two countries and see how they have implemented quantitative easing.

Japan’s Quantitative Easing Timeline

Japan plunged into a mild deflationDeflationDeflation is defined as an economic condition whereby the prices of goods and services go down constantly with the inflation rate turning negative. The situation generally emerges from the contraction of the money supply in the economy.read more in 2000. As part of the monetary policy, the Bank of Japan (BOJ) kept interest rates near zero for years since 1999. The country also introduced negative interest rates, which dissuades banks from keeping reserves instead of lending.

Over the years, the central kept pumping more liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more into the economy to enhance lending facilities. In 2014, BOJ announced the expansion of its bond-buying program to buy $723.4 billion of bonds a year. Due to the effect of aggressive quantitative easing, Japan’s balance sheet had expanded by $4.5 trillion in 2020. Japan also adopted yield curve control as part of QE.

Under yield curve control, it lowered the yield on its 10-year government bond to zero to drive up investments in other securities in the capital market. However, Japan still has not been able to increase inflation to the target 2%. Consumers are risk-averseRisk-averseThe term "risk-averse" refers to a person's unwillingness to take risks. Investors who prefer a low-return investment with known risks to a higher-return investment with unknown risks, for example, are risk-averse.read more. Instead of increased spending due to high money circulation, consumers are saving. Bank deposits of customers especially post Covid-19, grew to $ 7.4 trillion in 2020.

US Quantitative Easing Timeline

During the peak of the financial crisis in 2008, the Fed applied various quantitative easing measures in multiple phases, i.e., QE1, QE2 and QE3. It reduced interest rates to zero and started asset-buying on a massive scale. It bought millions of mortgage-backed debt (MBD) and Treasury notesTreasury NotesTreasury Notes are government-issued instruments with a fixed rate of interest and maturity date. As a result, it is the most preferred option because it is issued by the government (therefore, there is no risk of default) and also gives a guaranteed amount as a return, allowing the investor to plan accordingly.read more.

By 2014, the Fed had bought more than $3 trillion Treasuries and MBS and its balance sheet had swelled by $4 trillion. Over the years, the country has implemented many QE programs, helping it survive economic crises of different times. To battle the pandemic economic woes, the central bank has been buying $120 billion bonds per month since March 2020, $80 billion in Treasury assets and $40 billion of MBD.

Criticisms of Quantitative Easing

Many economists are wary of QE policies as they aren’t sure of their efficacy. Critiques argue that there is no guarantee of an economic recovery using QE. Moreover, it requires precision to be able to timely pull back some measures as enhanced money influx can lead to a string of problems, including inflation. Let us take a look at some of the criticisms of QE.


What does quantitative easing do?

The central bank issues new money by buying government and corporate securities from the open market as part of the quantitative easing policy. Large scale buying of government bonds increases their cost and decreases their interests, driving people to other investment securities to earn more. With more credit in the system, overall borrowing rates fall, leading to more borrowing, consumption and increased growth. Resultantly, it enhances business, prices, profits, wages and employment.

Is quantitative easing printing money?

Quantitative easing does not involve the printing of new banknotes and giving them away. Instead, the bank buys securities electronically, not using its existing balance but with a virtual supply of new money. With this, the bank’s balance sheet increases.

Does quantitative easing cause inflation?

Too much quantitative easing mostly increases inflation, sometimes to the extent of hyperinflation, since excessive money supply in the economy leads to a drop in its purchasing power.

This has been a guide on what is Quantitative Easing (QE). Here we discuss its definition along with examples from Japan, the US, UK, ECB and the process of Quantitative Easing.  You may have a look at these below articles for further learnings –

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