Quantitative Easing

Quantitative easing (QE) is an unconventional monetary policy used by central banks to stimulate the national economy when conventional monetary policy has become ineffective. A central bank implements quantitative easing by buying financial assets from commercial banks and other private institutions, thus creating money and injecting a pre-determined quantity of money into the economy. This is distinguished from the more usual policy of buying or selling government bonds to change money supply, in order to keep market interest rates at a specified target value. Quantitative easing increases the excess reserves of the banks, and raises the prices of the financial assets bought, which lowers their yield.

Expansionary monetary policy typically involves the central bank buying short-term government bonds in order to lower short-term market interest rates. However, when short-term interest rates are either at, or close to, zero, normal monetary policy can no longer lower interest rates. Quantitative easing may then be used by the monetary authorities to further stimulate the economy by purchasing assets of longer maturity than only short-term government bonds, and thereby lowering longer-term interest rates further out on the yield curve.

Quantitative easing can be used to help ensure inflation does not fall below target. Risks include the policy being more effective than intended in acting against deflation – leading to higher inflation, or of not being effective enough if banks do not lend out the additional reserves.