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Quantitative easing is an innovative and a non-conventional tool adopted by central banks to increase money supply in the economy when traditional monetary policies fail to stimulate growth. The Central bank buys long term fixed income bonds from commercial banks and other private institutions which increases the money supply and reduces the interest yield on these bonds. This is different from the traditional monetary policy of buying or selling short term government securities in order to keep interbank interest rates at a specified target value.
Quantitative easing is possible only if the central bank controls the currency.
For example, the US can implement quantitative easing because the Federal Reserve controls the supply of dollars. However the central banks of countries in the Eurozone cannot unilaterally expand their money supply and thus, cannot employ quantitative easing. They will have to rely on the European monetary union (European Central Bank).
The central bank prints money (or creates money electronically nowadays) to buy bonds. The money supply with commercial banks increases as the central bank keeps buying bonds. Commercial banks can use proceeds from the sale of bonds to lend it to companies and individuals. As money reserves with banks increase, the lending rate on loans falls, making cheap credit available to businesses and individuals. Companies can use these funds to invest in their business and individuals can use them for spending it on goods and services. The increase in investments and spending will improve the money supply in the economy.
As the money supply improves and the economy gets back on track, the Central Bank can sell these bonds and destroy the cash received from it.
Quantitative easing can be used to keep inflation rate on track. However, this policy will fail if banks are reluctant to lend additional funds or if individuals and businesses are not willing to spend or invest their surplus funds.
Quantitative easing was tried first by a central bank in Japan to get it out of a period of deflation in the late 1990s.
From 2008 onwards, it was used by US and European Union because their risk-free short-term nominal interest rates were either at or close to zero. In the United States, this interest rate is the funds rate; in the United Kingdom, it is the official bank rate. In 2008, the Federal Reserve started the first round of quantitative easing (QE1). In November 2010, the Fed announced a second round of quantitative easing (QE2), buying $600 billion of Treasury securities by the end of the second quarter of 2011. A third round of quantitative easing, “QE3”, was announced in September 2012. The Federal Reserve decided to launch a new $40 billion per month, open-ended bond purchasing program of agency mortgage-backed securities. Because of its open-ended nature, QE3 has earned the popular nickname of QE-Infinity. In December 2012, The Federal Reserve announced an increase in the amount of open-ended purchases from $40 billion to $85 billion per month.
About The Author
Asif is a student of Imarticus’ IFAP program. The Imarticus IFAP program, one of our finance courses, saw Pratik Biyani talk about Quantitative Easing last week. It was extremely well received and we requested one of our students, Asif Masani, to summarise his takeaways. When asked about his experinece at Imarticus, Asif responds that he loves Imarticus because, “I really like the innovative learning techniques used at Imarticus like, learning through case studies, movies, discussions etc. Also, I love the various guest lectures which are arranged by the Institute where we can interact and ask questions to the various professionals and gain from their rich industry knowledge and experience.”
He says, “I enjoy travelling, visiting new places which I did all 4 years while working on various outstation audit assignments. I love cycling, and I often go for long trips on my bicycle on weekends. I enjoy watching movies, especially action, adventure and science fictions. Also, I like watching football and cricket.”
When asked about his favorite books, he says, “I really haven’t read a lot of non fiction books. But thanks to Reshma and Pradeep (at Imarticus), I have made a start with Seven habits and the Barbarians at the Gate.”