Quantitative Easing
Quantitative Easing (QE) is a monetary policy tool used by central banks to stimulate economic growth when traditional methods, like lowering interest rates, are no longer effective, particularly when rates are close to zero. This strategy has been implemented by various central banks, including the Federal Reserve in the U.S., the European Central Bank, and the Bank of Japan, especially during periods of economic downturn such as the 2008 financial crisis and the COVID-19 pandemic. By creating new money to purchase government bonds and other financial assets, QE aims to increase the money supply in the economy, encouraging spending and investment.
The process works through several mechanisms: it provides funds to asset sellers, raises asset prices, lowers borrowing costs, and enhances the lending capacity of commercial banks. While a moderate level of inflation is often considered beneficial for economic growth, QE can lead to criticisms regarding potential government interference in the market and the risk of higher inflation rates. Evaluating the effectiveness of QE is complex, with mixed results reported across different economies and time periods. Its implementation reflects the ongoing challenges faced by policymakers in navigating the balance between growth and inflation in intricate economic environments.
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Quantitative Easing
Quantitative easing (QE) is a tactic used by central banks, such as the Federal Reserve Bank in the United States, to increase the money supply and stimulate growth when the more usual tactic of lowering the interest rate charged to banks is not possible. QE has been applied by several national economies in the twenty-first century, including Japan, the United States, and the United Kingdom, with mixed results. It is notoriously difficult to evaluate the effectiveness of strategies such as QE, and some criticize it as government interference in the private market and also as a process that may also produce higher prices and inflation.
Overview
In a country with a growing economy, the money supply increases each year. But if the money supply increases too quickly, this can produce inflation. A central bank can try to lower the rate of inflation by increasing the interest rate and thus reducing the money supply. QE addresses the opposite problem: in a weak economy, there may be too little money circulating, which can produce price deflation. Usually, a central bank can respond to this situation by buying short-term bonds or by lowering the rate of interest it charges to other banks, but if that interest rate is already near zero (known as the “zero lower bound”), this second strategy cannot be used.
While high and unstable inflation is considered damaging to individuals and to the economy, by essentially lowering the value of money and making people reluctant to invest, the goal of QE is often expressed as producing not zero inflation but a low and stable rate of inflation, because a small amount of inflation is considered beneficial to economic growth.
In the QE strategy, a central bank creates money and uses it to buy bonds. These purchases can stimulate the economy in several ways: by giving money to the sellers of the assets, who may invest or spend it; by increasing the price of the assets, also providing more money to the sellers to spend or invest; by lowering the yields of the assets, thus lowering the cost of borrowing for businesses and households and encouraging them to spend and invest more; and by increasing the money held by commercial banks, who may be encouraged to lend or invest more of it. Thus, ideally the money created by the central bank will work its way through the economy and encourage growth and investment.
The QE strategy was first applied in 2001 by the Bank of Japan and was also used by the US Federal Reserve Bank, the European Central Bank, and the Bank of England during the fiscal crisis that began in 2008. Because modern economies are extremely complex, it is difficult to evaluate whether QE had a beneficial effect in any particular circumstance, although economists such as James Bullard, writing in the Regional Economist in 2011, argued that the QE strategy applied in the United States from 2008 to 2010 was ineffective in improving economic conditions. In March 2020, the Federal Reserve again announced $700 billion in emergency quantitative easing to alleviate the economic downturn experienced at the onset of the COVID-19 pandemic. However, after 2021 saw a spike in inflation, 2022 saw significant increases in interest rates, and the Federal Reserve reduced its asset holdings.
Bibliography
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