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Explore the concept of quantitative easing, how it works, how it differs from traditional monetary policy, and its impact on global economies.
Quantitative easing (QE) is one of the most widely discussed monetary tools used by central banks in times of financial stress. It is often introduced when standard policy measures, such as adjusting interest rates, are no longer effective. By increasing the money supply, QE aims to encourage lending, stabilise financial markets, and stimulate economic growth.
Quantitative easing is a non-traditional monetary policy tool used by central banks to stimulate the economy when interest rates are already near zero. Under QE, the central bank purchases government securities, bonds, or other financial assets from the market.
By doing so, central banks inject liquidity into the financial system, lowering long-term interest rates and making borrowing cheaper. The ultimate aim is to boost consumer spending, encourage business investment, and support economic recovery.
The mechanism of quantitative easing can be understood through a few key steps.
Asset Purchases: The central bank buys large amounts of government bonds or other securities from banks and financial institutions.
Liquidity Injection: This action increases the reserves of commercial banks, giving them more funds to lend.
Lower Yields: As demand for government bonds rises, their yields fall, which reduces borrowing costs in the wider economy.
Stimulus Effect: Cheaper loans encourage households to spend and businesses to invest, supporting economic growth.
Through these steps, QE seeks to counter weak demand and restore confidence in financial markets.
The table below compares quantitative easing with traditional monetary policy tools.
| Aspect | Quantitative Easing | Traditional Monetary Policy |
|---|---|---|
Main Tool |
Large-scale asset purchases |
Adjusting short-term interest rates |
Target |
Long-term interest rates, liquidity |
Inflation, borrowing costs |
When Used |
When interest rates are near zero and growth is weak |
During normal economic cycles |
Impact |
Boosts lending, encourages spending, stabilises markets |
Controls inflation and stimulates or cools growth |
This comparison shows that QE is typically not a first-choice policy tool, but a measure taken during exceptional economic conditions.
A well-known example of quantitative easing is the programme launched by the US Federal Reserve after the 2008 financial crisis. The Fed purchased trillions of dollars’ worth of government securities and mortgage-backed securities to restore liquidity and stabilise markets.
Similarly, the European Central Bank (ECB) introduced QE in 2015 to address low inflation and sluggish growth in the Eurozone. These programmes demonstrate how QE is applied during financial crises to restore confidence and support recovery.
While not without criticism, QE can provide several important benefits when applied appropriately.
Helps stabilise financial markets during crises
Increases money supply, improving liquidity in the banking system
Lowers long-term borrowing costs, making credit more affordable
Encourages consumer spending and business investment
Prevents deflation by stimulating demand in the economy
Quantitative easing is often debated due to the potential risks it carries.
May create excessive liquidity, fuelling inflation if overused
Can distort asset prices, creating bubbles in stock or property markets
Reduces returns for savers due to prolonged low interest rates
Increases government debt levels as central banks buy large quantities of bonds
Effectiveness can diminish over time, especially if underlying structural issues are not addressed
Quantitative easing is a powerful but unconventional policy tool designed to stimulate economies during periods of severe stress. While it can restore confidence, improve liquidity, and lower borrowing costs, it also carries risks such as inflation and asset bubbles. For this reason, central banks typically adopt QE only under exceptional circumstances and alongside other economic reforms.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
Quantitative easing means that the central bank creates money to buy government bonds or other securities, injecting funds into the economy to encourage lending and spending.
Central banks use quantitative easing when traditional tools like lowering interest rates are no longer effective. It helps to boost liquidity, lower borrowing costs, and support economic growth during downturns.
The main risks of quantitative easing include the potential for higher inflation, asset price bubbles, and reduced returns for savers. Prolonged use may also lead to excessive government debt.
An example of quantitative easing is the US Federal Reserve’s bond-buying programme after the 2008 global financial crisis, which was aimed at stabilising markets and promoting recovery.
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