What Is Quantitative Easing? Advantages and Disadvantages of QE

Quantitative easing (QE) is a monetary policy that a central bank may adopt in times of economic instability to introduce more money into circulation. This strategy was first introduced by the Bank of Japan as a means of injecting “new money” into the economy, thereby “easing” the (low) quantity and expanding the central bank’s balance sheet.

A country’s central bank that is engaging in QE work will buy assets (like bonds and other securities) from commercial banks to introduce more money into circulation. This typically happens when short-term interest rates are at zero and consumers aren’t investing. Quantitative easing can theoretically boost a country’s economy by encouraging civilians to borrow from banks, which will be able to dole out easy, low-interest loans with their excess monetary reserves.

Quantitative easing involves a central bank—like the Federal Reserve System (commonly called the Fed in the United States) or the European Central Bank (or ECB) in Europe—purchasing assets from a private financial institution or lender. These assets may include mortgage-backed securities, government bonds, corporate bonds, treasury bills, or other long-term securities. When the central banks purchase these securities, they are increasing the financial reserves of the commercial banks.

In turn, banks are able to offer low interest rates to civilians and businesses in order to entice them to invest in areas like the housing market and stock market. Hence, money that was once in the government’s reserves is now in circulation, without the Fed literally printing money that is not backed up by assets. This is how quantitative easing can theoretically stimulate a country’s economy.

Quantitative easing is an unconventional monetary policy that a central bank will turn to in the face of widespread economic hardship. Some economists consider it a quick way of stimulating a country’s economy in times of dire economic crisis. Here are some of the advantages of QE.

1. 1. Low-risk lending for banks. Quantitative easing will typically only be introduced to an economic landscape where interest rates have dropped to zero percent. Adding money to a bank’s reserves in the face of these lower interest rates means that economic risk for banks lending money to civilians can remain low.
2. 2. Encourages people to spend. The purpose of QE is to level out markets to make spending and investing money more appealing and accessible to consumers. Lower interest rates can increase the likelihood that business and civilian borrowers will take out loans to make purchases, thereby boosting economic activity.
3. 3. Boosts the prices of assets. When the government participates in bond-buying during a QE measure, they replace the bonds with money that the previous bond-holder can reinvest in other assets in different financial markets, increasing their value.

Quantitative easing is a large-scale emergency measure that focuses on short-term economic growth, which can occur at the expense of a financial system’s long-term stability. Some of the potential drawbacks of QE can include the following.

1. 1. Can cause inflation. Adding currency into circulation can be tantamount to creating money out of thin air, which can contribute to inflation and lower bond yields. Inflation is the steady increase in the price of goods and services over time. It devalues units of currency (like the U.S. Dollar), resulting in consequences like a higher cost of living.
2. 2. Can cause stagflation. Stagflation refers to a rise in the cost of goods and living without yielding sufficient economic growth. When the central bank purchases financial assets, they are doing so to make it easier for others to make investments. However, during a great recession or global financial crisis, people are less likely to spend money, so there is no guarantee that the method will work.
3. 3. Impacts the value of a nation’s currency. Unless other countries are also taking quantitative easing measures, QE can drastically reduce the value of a country’s national currency. This is indicative of a decline in the international purchasing power—or the number of goods that one unit of currency can buy—of a country’s national currency.

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