What is Quantitative Easing?
Quantitative easing (QE) is a radical form of monetary policy where a central bank generates new money electronically to purchase financial assets, such as government bonds. The aim is to increase private sector spending to stimulate the economy, besides returning inflation to target.
Traditionally, in order to stimulate the economy, central banks would buy short term government bonds to lower short-term market interest rates. In a world of already low interest rates, this solution does not work. In this scenario, QE may be implemented to further stimulate the economy by purchasing assets with longer maturity, lowering long-term interest rates.
These tactics are usually part of an asset purchase programme (APP) and include the direct purchase of financial assets from commercial banks, such as sovereign debt, equities, corporate bonds or securities built on property loans. In addition to that, the central bank would sell less of its own gilts to institutions. Following the “monetarist” theory, all these measures combined would inject liquidity in the system and thus increase investment and spending.
The artificial increase of the money supply will most probably spark a raise in consumer prices, hence encouraging people to spend sooner rather than later.
Risks of QE
As it is a seldom used and unorthodox monetary tactic, we lack information on its long term effects on an economy. More importantly, QE is in effect printing money, without there being any increase in value in the economy.
This creates fears of the depreciation, or even complete destruction of a national currency’s value. ‘Printing money’ has led to the destruction of many currencies, and subsequently many nations.
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Category: Financial Glossary