Quantitative Easing (QE)

What Is Quantitative Easing (QE)?

When short-term interest rates are either at or approaching zero, the normal open market operations of a central bank, which target interest rates, are no longer effective. Instead, a central bank can target specified amounts of assets to purchase. Quantitative easing increases the money supply by purchasing assets with newly-created bank reserves in order to provide banks with more liquidity.

Understanding Quantitative Easing (QE)

To execute quantitative easing, central banks increase the supply of money by buying government bonds and other securities. Increasing the supply of money lowers interest rates. When interest rates are lower, banks can lend with easier terms. Quantitive easing is typically implemented when interest rates are already near zero, because, at this point, central banks have fewer tools to influence economic growth.

Special Considerations

If central banks increase the money supply, it can create inflation. The worst possible scenario for a central bank is that its quantitative easing strategy may cause inflation without the intended economic growth. An economic situation where there is inflation, but no economic growth, is called stagflation.

Although most central banks are created by their countries' governments and have some regulatory oversight, they cannot force banks in their country to increase their lending activities. Similarly, central banks cannot force borrowers to seek loans and invest. If the increased money supply created by quantitive easing does not work its way through the banks and into the economy, quantitative easing may not be effective (except as a tool to facilitate deficit spending).

Another potentially negative consequence of quantitative easing is that it can devalue the domestic currency. While a devalued currency can help domestic manufacturers because exported goods are cheaper in the global market (and this may help stimulate growth), a falling currency value makes imports more expensive. This can increase the cost of production and consumer price levels.

From 2009 until 2014, the U.S. Federal Reserve ran a quantitative easing program by increasing the money supply. This had the effect of increasing the asset side of the Federal Reserve's balance sheet, as it purchased bonds, mortgages, and other assets. The Federal Reserve's liabilities, primarily at U.S. banks, grew by the same amount and stood at over $4 trillion by 2017. The goal of this program was for banks to lend and invest those reserves in order to stimulate overall economic growth.

However, what actually happened was that banks held onto much of that money as excess reserves. At its pre-coronavirus peak, U.S. banks held $2.7 trillion in excess reserves, which was an unexpected outcome of the Federal Reserve's quantitative easing program.

Most economists believe that the Federal Reserve's quantitative easing program helped to rescue the U.S. (and potentially the world) economy following the 2008 financial crisis. However, the magnitude of its role in the subsequent recovery is actually impossible to quantify. Other central banks have attempted to deploy quantitative easing as a means of fighting off recession and deflation in their countries with similarly inconclusive results.

Examples of Quantitive Easing

Following the Asian Financial Crisis of 1997, Japan fell into an economic recession. Beginning in 2001, the Bank of Japan (BoJ) — Japan's central bank — began an aggressive quantitative easing program in order to curb deflation and stimulate the economy. The Bank of Japan moved from buying Japanese government bonds to buying private debt and stocks. However, the quantitive easing campaign failed to meet its goals. Between 1995 and 2007, the Japanese gross domestic product (GDP) fell from roughly $5.45 trillion to $4.52 trillion in nominal terms, despite the Bank of Japan's efforts.

The Swiss National Bank (SNB) also employed a quantitative easing strategy following the 2008 financial crisis. Eventually, the SNB owned assets that exceeded the annual economic output for the entire country. This made the SNB's version of quantitive easing the largest in the world (as a ratio to a country's GDP). Although economic growth has been positive in Switzerland, it is unclear how much of the subsequent recovery can be attributed to the SNB's quantitative easing program. For example, although interest rates were pushed below 0%, the SNB was still unable to achieve its inflation targets.

In August 2016, the Bank of England (BoE) announced that it would launch an additional quantitative easing program to help address any potential economic ramifications of Brexit. The plan was for the BoE to buy 60 billion pounds of government bonds and 10 billion pounds in corporate debt. The plan was intended to keep interest rates from rising in the U.K. and also to stimulate business investment and employment.

From August 2016 through June 2018, the Office for National Statistics in the U.K. reported that gross fixed capital formation (a measure of business investment) was growing at an average quarterly rate of 0.4 percent. This was lower than the average rate from 2009 through 2018. As a result, economists have been tasked with trying to determine whether or not growth would have been worse without this quantitative easing program.

How Does Quantitative Easing Work?

Quantitative easing is a type of monetary policy in which a nation’s central bank tries to increase the liquidity in its financial system, typically by purchasing long-dated government bonds from that nation’s largest banks. Quantitative easing was used in 2001 by the Bank of Japan (BoJ) but has since been adopted by the United States and several other countries. By purchasing these securities from banks, the central bank hopes to stimulate economic growth by empowering the banks to lend or invest more freely.

Is Quantitative Easing Printing Money?

Critics have argued that quantitative easing is effectively a form of money printing. These critics often point to examples in history where money printing has led to hyperinflation, such as in the case of Zimbabwe in the early 2000s, or Germany in the 1920s. However, proponents of quantitative easing will point out that, because it uses banks as intermediaries rather than placing cash directly in the hands of individuals and businesses, quantitative easing carries less risk of producing runaway inflation.

Does Quantitative Easing Cause Inflation?

There is disagreement about whether quantitative easing causes inflation, and to what extent it might do so. For example, the BoJ has repeatedly engaged in quantitative easing as a way of deliberately increasing inflation within their economy. However, these attempts have so far failed, with inflation remaining at extremely low levels since the late 1990s.

Similarly, many critics warned that the United States’ use of quantitative easing in the years following the 2008 Financial Crisis would risk unleashing dangerous inflation. But so far, this rise in inflation has yet to materialize.