Process
Ordinarily, a central bank conducts monetary policy by raising or lowering its interest rate target for the inter-bank interest rate. A central bank generally achieves its interest rate target mainly through open market operations, where the central bank buys or sells short-term government bonds from banks and other financial institutions. When the central bank disburses or collects payment for these bonds, it alters the amount of money in the economy, while simultaneously affecting the price (and thereby the yield) for short-term government bonds. This in turn affects the interbank interest rates.
If the nominal interest rate is at or very near zero, the central bank cannot lower it further. Such a situation, called a liquidity trap, can occur, for example, during deflation or when inflation is very low. In such a situation, the central bank may perform quantitative easing by purchasing a pre-determined amount of bonds or other assets from financial institutions without reference to the interest rate. The goal of this policy is to increase the money supply rather than to decrease the interest rate, which cannot be decreased further. This is often considered a "last resort" to stimulate the economy.
Quantitative easing, and monetary policy in general, can only be carried out if the central bank controls the currency used. The central banks of countries in the Eurozone, for example, cannot unilaterally expand their money supply, and thus cannot employ quantitative easing. They must instead rely on the European Central Bank (ECB) to set monetary policy.
Read more about this topic: Quantitative Easing
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