Quantitative easing

Definition

Quantitative easing is a monetary policy strategy used by central banks to stimulate the economy by increasing the money supply. This approach involves the central bank purchasing financial assets, such as government bonds and mortgage-backed securities, to lower interest rates and encourage lending and investment. By boosting liquidity in the financial system, quantitative easing aims to foster economic growth, particularly during times of economic downturns or when traditional monetary policies are ineffective.

5 Must Know Facts For Your Next Test

1. Quantitative easing was first prominently used by Japan in the early 2000s before being adopted by other countries during the 2008 financial crisis.
2. The Federal Reserve initiated several rounds of quantitative easing after the Great Recession, significantly increasing its balance sheet in the process.
3. One key goal of quantitative easing is to lower long-term interest rates, making borrowing cheaper for consumers and businesses.
4. Critics of quantitative easing argue that it can lead to asset bubbles and increased income inequality by disproportionately benefiting those who own financial assets.
5. Quantitative easing is considered a non-traditional monetary policy tool, used when conventional methods like lowering short-term interest rates are no longer effective.

Review Questions

• How does quantitative easing function as a monetary policy tool during economic downturns?
  • Quantitative easing functions by allowing central banks to purchase large amounts of financial assets, which increases the money supply and lowers interest rates. This makes borrowing cheaper for consumers and businesses, encouraging spending and investment. During economic downturns when traditional methods may not suffice, quantitative easing helps stimulate demand and support economic recovery by providing liquidity to the financial system.
• Evaluate the potential risks associated with implementing quantitative easing as a monetary policy strategy.
  • The implementation of quantitative easing carries several risks, including the possibility of creating asset bubbles as investors seek higher returns in a low-interest-rate environment. Additionally, it may contribute to long-term inflation if too much money enters circulation without corresponding economic growth. Critics also point out that quantitative easing can exacerbate income inequality since those who own assets may benefit disproportionately from rising prices in financial markets.
• Assess the impact of quantitative easing on economic recovery strategies post-2008 financial crisis, considering both successes and challenges.
  • Post-2008 financial crisis, quantitative easing played a crucial role in stabilizing the economy by increasing liquidity and encouraging lending. Central banks, particularly the Federal Reserve, saw success in lowering unemployment rates and fostering some degree of economic growth. However, challenges emerged as some sectors remained sluggish and wage growth lagged behind asset price increases. Furthermore, ongoing reliance on such non-traditional policies raised concerns about future inflation and market stability, making it clear that while quantitative easing was effective in some respects, it also introduced complexities that policymakers continue to grapple with.

Related terms

Central Bank: A national institution that manages a country's currency, money supply, and interest rates, and often oversees the banking system.

Inflation:

The rate at which the general level of prices for goods and services rises, eroding purchasing power.

Interest Rates: The amount charged by lenders to borrowers for the use of money, typically expressed as a percentage of the principal.