Definition Quantitative Easing. This involves increasing the Central Bank increasing the money supply and using these electronically created funds to buy government bonds or other securities.
The aim of Quantitative easing is to:
- Increase bank liquidity. When commercial banks sell bonds to the Central Bank, they have an increase in their cash reserves. This increase in cash deposits should, in theory, encourage commercial banks to lend to businesses.
- Through buying government bonds, the market price of bonds rises, leading to a reduction in long term interest rates. Lower interest rates should encourage greater economic activity in the economy.
When To Pursue Quantitative Easing
- Quantitative easing is often suggested as a solution to a liquidity trap. A liquidity trap occurs when cutting interest rates fails to boost economic activity. This is because despite low interest rates, banks are reluctant to lend and / or consumers are reluctant to borrow.
- Quantitative easing is also seen as a solution to deflation. During a period of deflation (falling prices) there is a reduction in consumer spending, often causing a recession. Quantitative easing can help increase inflation closer to the government’s inflation target of 2%.
Is Quantitative Easing like Printing Money?
- Yes, if the Central Bank create new money (electronically increase their bank reserves) then the effect is similar to printing money. They just avoid hassle of physically printing money and depositing it in their own bank account.
- In some cases, Central banks borrow money to buy government securities. Or they buy securities with existing this money. This is not actually increasing the money supply.
Does Quantitative easing cause inflation?
Increasing money supply can cause inflation. However, in a liquidity trap, an increase in the monetary base may have very little impact on inflation because banks don’t lend their bank reserves. See: Inflation and quantitative easing.
Examples of Quantitative Easing
- Quantitative easing was introduced in Japan in 2001 to try and overcome their deflationary recession.
- Quantitative easing was pursued by UK between 2008-2011.
- Quantitative easing in US 2009
Some economists argue that quantitative easing can work in cases of deflationary trap. In particular, it is important to change inflationary expectations from deflation to positive inflation.
Related
- Quantitative Easing Explained
- Who benefits from quantitative easing?
- Video on Quantitative easing
- Why we should aim for quantitative easing at FT
QE does not necessarily mean “printing” money. If The central bank purchases assets only from commercial banks then it increases reserves in the banking system but not money (e.g. M4).
Most QE in the UK has involved purchase of gilts from banks and so has not directly increased money. M4 declined around the time of QE.
It may be that QE prevented a greater decline in M4 and perhaps by so doing prevented a second recession…so far. Time for more?
Here is a recent video defining Quantitative Easing:
http://www.youtube.com/watch?v=j6BeLtDoSHY
Quantitative easing means the central bank handing over to the banks new notes in circulation instead of injecting these notes into the economy to support economic activity.