How Quantitative Easing Works

An explanation of how quantitative easing works in theory and practise.

Readers Question How is quantitative easing expected to benefit the UK economy looking at the current situation of the economy.

Readers Question: One more, is quantitative easing and stimulus package is the same?

The stimulus package refers to expansionary fiscal policy. This is tax cuts and government spending increases designed to increase aggregate demand through higher government borrowing.

Quantitative easing involves increasing the money supply through the creation of money.

The fear is that the UK economy is declining very rapidly. GDP growth is forecast to be -3.8% this year. Conventional policy (cutting interest rates and cutting taxes) have failed to stimulate the economy. Quantitative easing is being used to avoid the deflationary pressures which threaten the economy.

 

5 thoughts on “How Quantitative Easing Works

  1. Another way in which QE works is thus. QE involves giving the private sector monetary base in exchange for Gilts (“Treasuries” in the US). Monetary base pays no interest, or very little. So when the private sector gets cash for its Gilts it will then regard itself as having an excess stock of “Gilts plus cash” (because the more interest is obtainable on “Gilts plus cash” the bigger the stock of “Gilts plus cash” the private sector will want to hold). Thus the private sector will try to dissave cash. And that is reflationary.

    However this effect will be muted if (as is probably the case) the private sector thinks QE will be reversed quite soon. If this is the general expectation (which I guess it is) the private sector will just hold onto the cash pending a “QE reversal”.

    Incidentally, in the UK, QE has involve almost exclusively government debt (Gilts), whereas in the US a much broader range of securities have been QE’d.

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