Quantitative easing

Definition

Quantitative easing is a monetary policy used by central banks to stimulate the economy by increasing the money supply. This is achieved through the large-scale purchase of government securities and other financial assets, which lowers interest rates and encourages lending and investment. It aims to boost economic activity, especially during periods of low inflation and economic stagnation.

5 Must Know Facts For Your Next Test

1. Quantitative easing was prominently used during the 2008 financial crisis as central banks sought to stabilize the economy by preventing deflation and encouraging spending.
2. By purchasing large quantities of financial assets, quantitative easing increases the reserves of commercial banks, which can lead to increased lending to businesses and consumers.
3. Quantitative easing can lead to lower interest rates on loans and mortgages, making borrowing cheaper and stimulating economic growth.
4. One potential downside of quantitative easing is that it can contribute to asset bubbles as investors seek higher returns in riskier assets due to lower yields in safer investments.
5. The effectiveness of quantitative easing remains debated among economists, with some arguing it can lead to long-term economic distortions and others believing it is essential for recovery during downturns.

Review Questions

• How does quantitative easing influence interest rates and lending practices in the economy?
  • Quantitative easing influences interest rates by increasing the money supply through the purchase of financial assets, which helps lower interest rates across the board. When central banks buy government securities, they increase demand for these assets, driving their prices up and yields down. Lower yields on these securities encourage banks to lend more at lower rates, making borrowing cheaper for businesses and consumers, thus stimulating spending and investment.
• Evaluate the potential risks associated with quantitative easing as a monetary policy tool in the context of economic recovery.
  • The potential risks associated with quantitative easing include the creation of asset bubbles as investors search for higher yields in riskier assets due to artificially low interest rates. Additionally, prolonged quantitative easing can lead to rising inflation if the money supply grows too quickly relative to economic output. There’s also concern about long-term distortions in financial markets as businesses may become reliant on cheap credit instead of pursuing sustainable growth strategies.
• Critically analyze how quantitative easing has changed the relationship between central banks and global financial markets since its implementation during crises.
  • Quantitative easing has fundamentally altered the relationship between central banks and global financial markets by establishing central banks as key players in asset markets. Since its implementation during crises like the 2008 financial crisis, QE has led to significant shifts in market behavior where investors now often anticipate and react to central bank policies. This new dynamic means that central banks wield considerable influence over asset prices and market stability, raising concerns about moral hazard where investors may take on excessive risk expecting central bank intervention in future downturns.

Related terms

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

Central Bank: A national bank that provides financial and banking services for its country's government and commercial banking system, while also implementing monetary policy.

Asset Purchases: The act of acquiring various financial assets, such as government bonds or mortgage-backed securities, by central banks to influence liquidity and interest rates in the economy.