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Quantitative easing (QE) is a monetary policy used by central banks to stimulate the economy by buying back government bonds or other financial assets from banks, to increase the money supply and lower interest rates. This usually happens when standard forms of monetary policies are no longer effective when a country’s interest rates have plummeted to near zero.
The theory behind quantitative easing is relatively simple. By increasing the supply of money in the economy, central banks can stimulate economic activity and boost inflation. When central banks buy government bonds or other securities from financial institutions, they inject money into the economy and increases the banks’ reserves, which in turn increases lending to businesses and individuals. This increases the demand for credit, which boosts spending and investment and revives the economy.
The main aim of QE is to lower interest rates in the long term, so as to make it cheaper for businesses and individuals to borrow money and encourage spending and investment. This can potentially lead to an increase in stock and property prices, in turn leading to a boost in household wealth. QE can also help prevent deflation, which is the phenomenon when prices and economic activity decline.
QE does come with its own risks. If too much money is injected into the economy, it can lead to hyper-inflation. If investors use the additional liquidity to invest in risky assets, it can also lead to asset price bubbles, which is when the price of assets become inflated beyond their fundamental values. This rapid price increase leads to sudden and sharp decreases that can result in significant losses for investors.
A famous example of quantitative easing took place during the global financial crisis of 2008. The US Federal Reserve implemented a large-scale QE programme by purchasing billions of dollars in mortgage-backed securities and US Treasury bonds. This injected liquidity into the market and encouraged lending and investment at large, which helped to stabilise the economy and prevent a more severe recession.
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