What is Quantitative Easing (QE)?

//What is Quantitative Easing (QE)?
What is Quantitative Easing (QE)? 2017-10-09T07:59:53+00:00

Definition: Quantitative easing (QE) is an expansionary monetary policy in which the central bank buys government securities or assets from the secondary market and the financial institutions to boost economic activity during periods that the government’s monetary policy fails to bring the expected results.

What Does Quantitative Easing Mean?

What is the definition of quantitative easing? The quantitative easing is often implemented as a solution to liquidity problems in an economy when lower interest rates fail to enhance economic activity. By buying government bonds, the central bank causes their price to rise while increasing the supply of money in the economy. As a result, the available funds of commercial banks increase and can be invested in the purchase of new financial products, thus causing an increase in the lending and liquidity levels.

It is also suggested when there is a prolonged period of falling prices (deflation), which lowers consumer spending. For the successful implementation of QE, commercial banks to place surplus funds on the market and the central bank has to be in control of the country’s currency.

Let’s look at an example.

Example

To increase the liquidity in the capital markets, the Fed expanded its open market operations by cutting the interest rates to 0.25% and buying mortgage-backed securities. The increased money supply has enabled the commercial banks to sell more loans, thus stimulating business lending and consumer credit demand. In the period December 2008 – October 2014, the Fed implemented three rounds of quantitative easing, accruing a total of $4.5 trillion in Treasury notes and mortgage-backed securities.

Although the Fed’s goal was to increase the available credit, the QE failed to boost the economic activity. The banks could not lend the money to consumers because consumer confidence was low following the financial crisis. To disperse the funds, commercial banks had to triple their stock prices to intrigue investors buy their stocks, and they also distributed cash dividends. Furthermore, in 2014, the US dollar appreciated 15%, which is not what the QE normally causes, i.e. depreciation of the domestic currency and a lower exchange rate. Therefore, the US exporters were not benefited from a lower exchange rate. Instead, the US importers could import at a lower price.

Summary Definition

Define Quantitative Easing: QE is an economic policy where central banks buy bonds and T-bills on the open market to increase the money supply in an effort to stimulate economic growth.