Quantitative Easing
Paras Aggrwal
Quantitative Easing
Quantitative easing is the monetary policy used by a central bank to stimulate an economy when standard monetary policy has become ineffective. A central bank implements quantitative easing by buying specified amounts of financial assets from commercial banks and other private institutions, thus raising the prices of those financial assets and lowering their yield, while simultaneously increasing the monetary base. This differs from the more usual policy of buying or selling short-term government bonds in order to keep interbank interest rates at a specified target value.
Expansionary monetary policy to stimulate the economy typically involves the central bank buying short-term government bonds in order to lower short-term market interest rates. However, when short-term interest rates reach or approach zero, this method can no longer work. In such circumstances monetary authorities may then use quantitative easing to further stimulate the economy by buying assets of longer maturity than short-term government bonds, thereby lowering longer-term interest rates further out on the yield curve.
Governments and central banks like there to be "just enough" growth in an economy - not too much that could lead to inflation getting out of control, but not too little that there is stagnation. Their aim is the so-called "Goldilocks economy" - not too hot, but not too cold.
Quantitative easing was first used by the Bank of Japan (BOJ) to fight domestic deflation in the early 2000s. The Bank of Japan had for many years, and as late as February 2001, claimed that "quantitative easing ... is not effective" and rejected its use for monetary policy. However, under quantitative easing, the BOJ flooded commercial banks with excess liquidity to promote private lending, leaving them with large stocks of excess reserves and therefore little risk of a liquidity shortage. Now the BOJ buys 80 trillion Yen of bonds a year.
Since the advent of the global financial crisis of 2007–08, similar policies have been used by the United States, the United Kingdom.
Risks include the policy being more effective than intended in acting against deflation (leading to higher inflation in the longer term, due to increased money supply and constant number of goods) or not being effective enough if banks do not lend out the additional reserves. Some worry that the flood of cash has encouraged reckless financial behavior and directed a fire hose of money to emerging economies that cannot manage the cash. Others doubt that central banks have the capacity to keep inflation in check if the money they have created begins circulating more rapidly. It can also cause devaluation of money, resulting in creditors losing out and harm the importers.
According to the International Monetary Fund and various economists, quantitative easing undertaken since the global financial crisis of 2007–08 has mitigated some of the adverse effects of the crisis. There is now talk of implementing this by the European Central Bank, who has so far abstained from its implementation, albeit with slight modifications.
The jury, however, is still out to gauge this policy. It may not be the best, but certainly is effective.