Quantitative easing

Definition

Quantitative easing is a non-traditional monetary policy tool used by central banks to stimulate the economy by increasing the money supply. It involves the central bank purchasing government securities and other financial assets to inject liquidity into the economy, aiming to lower interest rates, promote lending, and encourage investment when traditional monetary policy tools have become ineffective.

5 Must Know Facts For Your Next Test

1. Quantitative easing was widely adopted after the 2008 financial crisis when traditional monetary policy tools, like lowering interest rates, reached their limits near zero.
2. This policy can lead to lower long-term interest rates, making borrowing cheaper for consumers and businesses, thus stimulating economic activity.
3. One potential downside of quantitative easing is the risk of inflation if too much money is injected into the economy without corresponding economic growth.
4. Central banks monitor the effects of quantitative easing closely, as it can impact exchange rates and lead to asset bubbles if investors seek higher returns in riskier assets.
5. Quantitative easing is often seen as a controversial tool, with debates about its long-term effectiveness and potential consequences on income inequality and wealth distribution.

Review Questions

• How does quantitative easing function as a tool of monetary policy to influence economic activity?
  • Quantitative easing functions by allowing central banks to purchase government securities and other financial assets to increase the money supply. This injection of liquidity helps lower interest rates, which in turn encourages borrowing and spending by consumers and businesses. As credit becomes more accessible and affordable, economic activity is stimulated, aiming to counteract slow growth or deflation in the economy.
• Discuss the potential risks associated with quantitative easing and its impact on financial markets.
  • The potential risks associated with quantitative easing include inflationary pressures if too much money is introduced into the economy without corresponding growth. Additionally, it can lead to distorted asset prices as investors search for yield in riskier assets, potentially creating asset bubbles. The policy also affects exchange rates, which can lead to competitive devaluations among countries seeking to boost their exports.
• Evaluate the long-term implications of quantitative easing on income inequality and economic stability in a post-crisis environment.
  • The long-term implications of quantitative easing on income inequality stem from its effects on asset prices, which tend to benefit wealthier individuals who hold stocks or real estate. As these asset prices rise due to increased liquidity, those without such investments may not experience similar gains, widening the wealth gap. Moreover, prolonged reliance on this policy could result in economic instability if it leads to inflation or financial bubbles that require eventual correction, challenging policymakers in sustaining balanced growth.

Related terms

Monetary Policy: The process by which a central bank manages the money supply and interest rates to achieve macroeconomic goals such as controlling inflation, consumption, growth, and liquidity.

Interest Rates: The cost of borrowing money or the return for lending it, usually expressed as a percentage; they are a key tool for monetary policy and are influenced by the central bank's actions.

Liquidity: The availability of liquid assets to a market or company, which is essential for ensuring that financial institutions can meet their short-term obligations.