Quantitative easing definition

A policy tool used by central banks to encourage economic growth by increasing the money supply.

What is quantitative easing?

Quantitative easing is a policy tool used by central banks to encourage economic growth. It’s usually a last resort when standard monetary policy measures (like lowering short-term interest rates) are no longer effective.

Under quantitative easing, a central bank will purchase financial assets (usually government bonds) in order to increase the money supply and bring down long-term interest rates. The opposite of quantitative easing is quantitative tightening.

 

How does quantitative easing work?

Quantitative easing has a few steps to run through in order to fully understand how it works. Some people say it’s just ‘printing more money’, but it’s not as simple as that. Here’s a simple guide to how quantitative easing works.

Asset purchases: a central bank (that’s the Bank of England in the UK), buys financial assets from banks and other financial institutions. These assets are usually government bonds, but they can also include mortgage-backed securities and other types of debt.

Increased bank reserves: when a central bank buys these assets, it credits the accounts of the sellers (these tend to be large corporations, including retail banks like Barclays, HSBC, and Santander). This increases the cash reserves in circulation.

Lower long-term interest rates: the increased demand for financial assets like bonds will hopefully mean that their prices start to rise, which in turn will hopefully lead to a decrease in their interest rates. That’s because bonds and interest rates have what’s called an ‘inverse relationship’. When interest rates rise, bond prices tend to fall – and when interest rates fall, bond prices tend to  rise.

Encouraging borrowing and investment: lower interest rates can encourage businesses and individuals to borrow money at cheaper rates, stimulating investment, spending, and economic growth.

Quantitative easing is typically used during times of economic downturn (like a recession or financial crisis) to help lower long-term interest rates and encourage economic activity. It’s also used to combat deflation, as it increases the money supply, making it easier for central banks to achieve their inflation targets.

Potential side effects of quantitative easing include rising inflation, asset bubbles, and income inequality. That’s why it’s often a ‘last resort’ economic policy, and central banks will manage the implementation of quantitative easing carefully to make sure they achieve their goals while minimising the risks to consumers.

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