Quantitative Easing Definition

Definition Quantitative Easing. This involves the Central Bank increasing the money supply and using these electronically created funds to buy government bonds or other securities to reduce interest rates in the economy.

Quantitative easing is a form of expansionary monetary policy. It is usually used in a liquidity trap – when base interest rates cannot be cut any further.

Aim of Quantitative Easing

1. Increase economic activity – Q.E. aims to encourage bank lending, investment and therefore help improve the rate of economic growth.
2. Higher inflation rate. Quantitative easing may also be used to avoid the prospect of deflation.
3. Lower interest rates on assets

How Quantitative Easing Works

1. The Central Bank creates money electronically. (This is a similar effect to printing money, except they are increasing bank reserves which don’t need to be printed in the form of cash)
2. The Central Bank uses these extra reserves to buy various securities. These include government bond and corporate bonds.

Buying these securities achieves two things:

1. Increased liquidity. Banks sell assets (bonds) for cash. Therefore banks see an increase in their liquidity (cash reserves). In theory, the bank will then be more willing to lend to customers. This lending will be important for increasing investment and consumer spending.
2. Lower interest rates. Buying assets reduce their interest rate. Lower interest rates on these securities may also encourage banks to lend rather than keep securities which are paying low interest. Higher lending should help improve economic growth.

• Increase bank lending leading to higher investment. This should stimulate economic growth
• Increase inflation. Quantitative easing may be pursued when there is underlying core-inflation close to 0%. 0% inflation and deflation can lead to lower spending and economic growth. Therefore, aiming for a higher inflation rate can encourage spending.

Did quantitative easing work between 2009-2020?

Between March 2009 and Sep 2020, the Bank of England created £895bn of new money. This was used to purchase government gilts (bonds). It meant by 2020, a third of all government gilts were held by the Bank of England

This shows a change in bank reserves at Bthe ank of England. There were four main periods of QE. The impact on the money supply was fairly muted at least until 2022

The Bank of England stated that QE inflated real house prices and equity prices. This is because QE increases commercial bank reserves – more to lend for mortgages and also interest rates are low – mortgages are cheaper.

Quantitative Tightening

This is the process of reversing quantitative easing and reducing the amount of money in the economy by shrinking its balance sheet.. It involves the Central Bank allows maturing bonds to expire or actively selling bonds back onto the open market, to reduce the Central Banks holdings of gilts.

Impact of QE in UK 2009-2025

The reason for QE was the fact economic growth was substantially below the post-war trend. QE was relatively ineffective in boosting economic growth.

Effect of QE on bond yields

The process of QE saw bond yields fall throughout the 2010s. Bond yields rose when inflation returned and the bank started to reverse QE after 2022.

The fall in bond yields made government borrowing cheaper, and in theory, encourages more profitable investment. However, bank lending was very slow to recover, suggesting quantitative easing was relatively ineffective in boosting bank lending.

See also: Problems and limitations of quantitative easing

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 fail 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 creates new money (electronically increase their bank reserves) then the effect is similar to printing money. They just avoid the hassle of physically printing money and depositing it in their own bank account. However, it really depends how commercial banks use this created money. If they don’t want to lend it, it has little effect on increasing broad 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.

The UK didn’t really have much inflation during process of quantitative easing until 2022 after last batch of QE. The inflation was caused by rising oil prices, covid supply constraints and excess demand in the economy.

Alternatives to quantitative easing

• Helicopter Money – creating money and giving to consumers directly

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 2009-2021
• Quantitative easing in US 2009-22

Some economists argue that quantitative easing can work in cases of a deflationary trap. In particular, it is important to change inflationary expectations from deflation to positive inflation.

What happens when quantitative ends?

There will come a point when the Central Bank reverse the policy of quantitative easing. They will sell the bonds they have accumulated on the bond market. This will cause interest rates to rise, and reduce the growth of the money supply. The policy will be reversed when the economy is sufficiently strong to cope with rising interest rates and a fall in bank cash reserves.

See more at What happens when quantitative easing is reversed

Related

• Quantitative Easing Explained
• Who benefits from quantitative easing?
• Why we should aim for quantitative easing at FT

About The Author

Tejvan Pettinger

Tejvan Pettinger. Author of “Cracking Economics” “What Would Keynes Do?” – studied PPE Oxford University (1995-99) and works as an economics teacher and writer.

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