Quantitative easing, the tool all of us pretend to understand

Quantitative easing, the tool all of us pretend to understand

Quantitative Easing is the economic concept that few of us really grasp. So, why don’t we find more about it?

When an economy is in danger of falling into recession, governments can resort to a strategy commonly known as quantitative easing (Q.E.). In short, quantitative easing programs have the role of stimulating economies. By injecting money into economies, governments try to keep the interest rates at low levels, making borrowing and investing cheaper. At the same time, they provide consumers with extra funds to spend. However, if not correctly taken care of, Q.E. can lead to inflation, and more problems.

Quantitative Easing detailed

Every major country in the world has its economy managed by a central bank. The four largest Central Banks are the U.S. Federal Reserve, the Bank of Japan, the Bank of England, and the European Central Bank. Their main task is to handle the monetary policies and keep currencies under control.

If economies are struggling, central banks cut interest rates. Thus, investing and borrowing money becomes more affordable. But keeping money in banks isn't always viable because of reduced interest rates. Then, how can the banks bring more wealth into the economy? Quantitative easing programs come into play here.

Q.E. programs and money printing

When launching a Quantitative easing program, the central bank creates electronic money. People call this process "money printing."

The classic type of Q.E. stimulus program is when the central bank buys government bonds on the open market, basically buying back its own bonds. Also, central banks can acquire private sector bonds (the ECB does that) or mortgage-backed loan products (as is the Fed’s case).

At a certain point, banks stop the bonds buying process. Yet, they will keep the ones they possess, replacing them from time to time with matured bonds*.

* Bonds have a maturity date happening when the initial investment is repaid to the owner.

Additionally, they can reverse the process and sell the bonds back into the market. Also, they can let the bonds on their balance sheet mature without replacing them.

There are several possible scenarios for each option:

- allowing the bonds to mature will slowly remove the cash from the market (as the bank's bonds are paid off)

- selling them will remove money out of the market more quickly

- renewing them as they mature will keep the cash flow going at a steady pace

What are the advantages of using QE programs?

1. They provide aid for the jobs sector

Since businesses can access more funds, this money can be put to good use, such as creating new jobs.

2. Support lending, borrowing, and spending

By reducing long-term rates, banks are willing to lend money at lower rates, stimulate economies, and increase consumer spending and borrowing.

3. Support lower interest rates

Central banks like the Fed can stimulate the economy by reducing the federal funds rate during Q.E. programs and encourage lending.

What about the risks of using QE stimulus programs?

There are several reasons why people put Q.E. programs under scrutiny:

1. It can drive inflation higher – the most significant concern surrounding Q.E. programs

Even though the money supply goes way higher, the supply of goods & services stays the same. What happens in such a case? Prices can only increase, resulting in higher inflation.

2. Problems with international trade

With the freshly “printed” money, countries can import new goods and services from other states. However, since these funds are artificially created, the value of the importer’s currency decreases, discouraging exporters.

3. The benefits are only short-term

When the central bank stops printing money, things can go either way. Although the hope is that new consumer confidence will inspire a real recovery, many feel these will only provide a temporary fix. Furthermore, the stock markets frequently fall when announced or speculated that the quantitative easing programs will end, causing even more uncertainty.

4. Debt can skyrocket

Increased money supply and low-interest rates encourage additional borrowing by both consumers and businesses. While some debt can help stimulate an economy, wanton loans and excessive debt can further exacerbate an already fragile one.

Quantitative Easing Interesting Facts

Japan was the first country to resort to Q.E. programs, from 2001 to 2006. The state resumed its Q.E. stimulus in 2012 with the election of Shinzo Abe as Prime Minister.

In December 2008, the Fed fought the financial crisis by launching four consecutive Q.E. rounds. These lasted until December 2014.

The European Central Bank first adopted Q.E. in January 2015 after seven years of austerity measures.

Trying to protect the U.S. economy against the Covid-19 pandemic, the Federal Reserve announced a Q.E. program in March 2020 that amounted to over $700 billion.

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Sources: investopedia.com, the balance.com,weforum.org

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