Quantitative easing definition
monetary policy tool used for the creation of “new” money for the purpose of increasing the money supply
Quantitative easing meaning
A technique used by a Central Bank (CB) in a situation when other instruments for increasing the money supply and credit potential of banks are not effective. To overcome this problem, a CB uses quantitative easing as a method to increase the money supply by buying government and other securities from banks and other financial institutions. Purchasing these assets increases the credit potential and liquidity of banks. The expectations being that increased liquidity will increase the demand for funds. Hence, it will stimulate economic growth through easier access to loans for individual borrowers and the business sector.
Quantitative easing explained
Quantitative easing is also referred to as “QE” or “asset-purchase”. It is implemented when there is a danger that the economy will fall into recession, and the traditional monetary policy instruments have been ineffective.
In reality, the newly created money does not change hands. Instead, the Central Bank credits banks’ reserves with the amount from the purchase of the securities. The central bank creates the amount of money needed, and consequently, the money supply in the economy is increased.
This newly created money should support economic growth through the promotion of spending and investing. Namely, in a low interest rate environment, banks will have more money available for crediting individual customers and business customers. Increased availability of loans should increase the level of spending and investments made by companies.
What is quantitative easing?
This technique became especially popular after the last financial crisis that took place in 2008. It is a technique to increase the availability of funds in the economy. Since the price of money depends on supply and demand, as with other goods, any increase in the supply should result in a decrease in the price. One of the things which is sometimes difficult to grasp is a CB’s source of funds. Namely, where does the CB find money to make the purchases? It should be understood that CB is simply creating the money itself i.e., it is creating digital money.
When interest rates are down to zero percent or around zero percent, the CB cannot use traditional instruments to target low interest rates. The method available to increase economic activity is to increase the money supply using QE.
Although QE was used by CBs after the 2008 crisis, it does have some negative aspects. QE has a possible negative effect on inflation, and creates the danger that individuals and companies could be faced with excessive debt levels.