Some have hailed quantitative easing as a savior in times of economic crisis. Others also criticize it as an ineffective measure that only helps some of the rich. While it’s true that QE doesn’t always work as well as it should, there are ways to make quantitative easing more effective and less risky.
What is quantitative easing?
QE is a process where central banks buy up assets, like government bonds or mortgages. QE can be used to stimulate the economy by reducing interest rates and increasing the money supply.
Banks can also use it to reduce the value of a currency and increase exports by making exports cheaper for other countries. That is done by buying foreign currencies and selling foreign bonds in exchange for domestic currency.
How does quantitative easing work?
When central banks want to stimulate the economy, they buy assets. The process of buying these assets is called quantitative easing.
The idea behind quantitative easing is that increasing the money supply will make it easier for businesses to borrow and invest in their businesses. Doing so increases spending and stimulates economic activity.
Quantitative easing works when interest rates are low because it further reduces borrowing costs.
Why do central banks use quantitative easing?
Why would a central bank want to use quantitative easing?
It’s a tool that one can use to increase the money supply. If you’ve ever heard of “printing money,” this is one way for it to happen.
In addition to adding more cash into circulation, QE also manipulates interest rates and makes borrowing cheaper. That makes it cheaper for people and businesses to borrow money. In addition, it increases spending on consumer goods and investment in capital projects like buildings or cars.
This increased spending leads businesses to hire more workers who will spend their wages again and pay off debt faster. It leads to a virtuous cycle where everyone spends more money than they did before (creating jobs).
That cycle was responsible for most economic growth between 2008-2018 because it aimed to get consumers going again. Consumers were struck by recessionary forces such as reduced access to credit markets caused by the financial crisis of 2007-2008.
Where did quantitative easing start?
Quantitative easing is a policy used by central banks to stimulate the economy. It was first introduced by the Federal Reserve in the US but has since been adopted by other countries worldwide.
The Federal Reserve started quantitative easing in response to the 2008 financial crisis, which caused many banks to fail and left many ordinary Americans without jobs and savings. The Fed wanted to help these people get back on their feet by pumping money into their economy—but how?
QE works like this:
The Fed buys assets from private banks or financial institutions. It holds trillions worth of bonds as of 2022. The process pumps liquidity into those institutions so they can go out and lend more money. That increases liquidity in markets that need it most (for example, markets for commercial paper and corporate loans)
It is why some people think QE is a bad thing.
The main concern with QE is that it is a form of “money printing” and can lead to inflation. That is because when you print more money, the value of each currency unit decreases.
Inflation means an increase in prices. Some argue that this makes goods more expensive for people who are just getting by on fixed incomes, like retirees or students (who aren’t paid as much). In other words, inflation can make things harder for low-income households. It also means higher interest rates for loans. Those higher interest rates can make it harder for business owners to borrow money when needed. Moreover, it could slow down economic growth and hire even further.
Indeed, these effects aren’t felt right away. The price increases don’t kick in until after the policies have been implemented. But they’re still possible outcomes worth considering before making big decisions about our economy’s direction!
What are the alternatives to QE?
When considering alternatives to QE, it’s important to remember that there are only two ways to affect the economy: Fiscal Policy and Monetary Policy.
Fiscal Policy uses government spending or tax cuts to stimulate the economy. It can be done through direct government spending on public works projects or by cutting taxes for individuals or businesses.
Monetary Policy uses interest rates, credit controls, and other central banking tools to control inflation and keep unemployment low.
While both fiscal and monetary policies have pros and cons, QE has some unique drawbacks compared with other tools in each category.
Is quantitative easing that bad?
Quantitative easing can have several undesirable effects on the economy. For example, QE may create inflationary pressures by increasing the money supply. That is problematic: prices rise when too much money is chasing too few goods or services.
In addition to causing inflation, it’s also possible that quantitative easing could contribute to another financial crisis like the one we saw in 2008. If banks are given too much money at once and lend it excessively (like they did before), then there’s an increased risk that some borrowers won’t be able to pay back their loans. If these borrowers fail to repay what they owe banks, then those banks might fail as well!
Finally, QE has been used explicitly for political purposes—such as propping up stock markets or bailing out companies like General Motors Corporation.
Quantitative Easing can enable growth and financial stability, but it doesn’t come without risks
Quantitative easing is a monetary policy that has the potential to help prevent deflation, raise inflation expectations, reduce interest rates, increase the money supply and boost asset prices.
So why hasn’t it worked too well? Because it isn’t used correctly and far too often.
Conclusion
Quantitative easing is a complex tool, but banks can use it to help stabilize the economy.
When used correctly and responsibly, QE can be very useful in helping us through a crisis. That said, there are risks that they must take into account before implementing any new policy such as this one.
Among them are hyperinflation (which could result if too much money is printed out of thin air) or higher interest rates (because banks will try to make up for lost profits on loans).
But overall? The benefits traditionally outweigh the drawbacks!