Quantitative easing
Family IX · Macro
Not to be confused with monetary policy, interest rate decision, central bank.
Quantitative easing is an unconventional monetary policy tool in which a central bank electronically creates new reserves to buy assets, usually government bonds or mortgage-backed securities, from banks and other financial institutions. It is deployed when short-term policy rates are already near zero and further cuts are ineffective, aiming to lower long-term borrowing costs and stimulate lending. The scale, pace, and composition of asset purchases vary by central bank and economic conditions.[1]
How it works
In normal monetary policy, a central bank adjusts the short-term policy rate to influence borrowing costs. When that rate approaches zero, quantitative easing becomes an option. The central bank credits its own account to buy assets, typically long-dated government bonds, from commercial banks and other sellers. This increases the reserves held by banks and raises the price of the purchased assets, which lowers their yield. Lower long-term yields reduce borrowing costs for households and businesses, and the added liquidity may encourage lending and investment.
The central bank's balance sheet expands by the amount of assets purchased. The exact size and duration of a QE programme are determined by the central bank's mandate and economic outlook, and can differ substantially across countries and time periods.
Worked example
Suppose a central bank announces a QE programme of 100 billion in government bond purchases. It buys bonds from banks, paying with newly created reserves. The banks' reserve balances rise by 100 billion, and the central bank's balance sheet grows by the same amount. If the purchases push the yield on 10-year government bonds down from 2.0% to 1.5%, a corporate borrower with a 1.0% spread over that bond might see its long-term borrowing cost fall from 3.0% to 2.5%.
Context and variations
Quantitative easing has been used by major central banks such as the Federal Reserve, the European Central Bank, the Bank of England, and the Bank of Japan, but the specific design, communication, and exit strategies differ. Some central banks focus on government bonds, while others include mortgage-backed securities or corporate bonds. The effectiveness of QE is debated; it can lower yields and support asset prices, but may also contribute to inflation, asset bubbles, or income inequality. The timing and magnitude of QE are not fixed rules and depend on the central bank's assessment of economic conditions.
Often confused with
- monetary policy
- Monetary policy is the set of actions a central bank takes to manage the money supply and short-term interest rates in order to influence inflation, employment and economic activity.
- interest rate decision
- An interest rate decision is the formal announcement by a central bank's policy committee of the target level for its policy interest rate, or of a change to that level, following a scheduled or ad hoc policy meeting.
- central bank
- A central bank is a national institution that issues legal-tender currency, sets the base interest rate, and supervises the banking system, operating under a mandate that varies by country.
See also
References
- ↑ Policy rate publications of the relevant central banks. Overnight financing follows the interest-rate differential between the two currencies, plus the broker's own markup, so the figure is not fixed.