There is now speculation that the Federal Reserve – the US central bank – is about to relaunch a program called quantitative easing. But what is this unorthodox policy measure?
What is QE?
Quantitative easing is an unconventional monetary policy tool employed by central banks to purchase government and financial assets from member banks. Central banks execute this by increasing the money supply with newly printed bank reserves (cash held by banks) that then inject liquidity (cash) into financial markets.
When central banks expand the money supply, they lower the cost of money, which decreases interest rates. According to the Bank of England:
An interest rate is a percentage charged on the total amount you borrow or save.
If you’re a borrower, the interest rate is the amount you are charged for borrowing money – a percentage of the total amount of the loan… Interest is what you pay for the privilege. It’s a bit like hiring a car. Interest is what you pay to ‘hire’ someone else’s money. If you’re a saver, it’s the same except the interest fee is paid to you – because banks are paying to hire your money.
Quantitative Easing (QE) enables financial institutions to lend money to people more easily since interest rates are lowered. The purpose of QE is to cut rates to boost lending, make borrowing cheaper, and encourage economic growth.
2008 saw the “global economic crisis” and a global recession (economic decline). QE was quite common in the aftermath of the 2008 recession. The strategy was employed by the Federal Reserve in the US as well as the European Central Bank (ECB), and the Bank of England (BoE). The Fed launched three rounds of QE. In 2014, it began to scale back. Other central banks, like the Bank of Japan (BOJ), had already introduced a series of QE programs before the financial crisis.
Pros and Cons
One of the biggest concerns about quantitative easing is the possibility of unleashing a tidal wave of inflation. Because there is a substantial increase in the amount of money in the economy, this would devalue the currency. This can make imports more expensive and erode consumers’ purchasing power.
Since central banks cannot force borrowers to apply for loans or mandate financial institutions to lend, QE may not achieve its goal. Therefore, central banks may keep implementing multiple rounds of QE. Ultimately, the economy is flooded with too much cash.
A benefit of QE is that if a central bank is successful in devaluing a currency, then it can be a boon for manufacturers and exporters because it makes their products cheaper in global markets, compared to other currencies.
When QE decreases interest rates, it makes borrowing a lot cheaper, and it makes debt payments more affordable.
One of the mandates assigned to the Fed when it was first established was to maximize employment. In the short-term, QE facilitates this by ensuring that jobless rates do not fall for a prolonged period.
Experts will say that QE not only helps Wall Street, but it also benefits Main Street – in the short run.