Quantitative Easing (QE)

Quantitative easing (QE) is an unconventional monetary policy employed by central banks to invigorate the economy when traditional monetary measures are ineffective. It is often informally referred to as “printing money”, although no physical banknotes are actually produced. Instead, money is electronically “created” or “keystroked.” Terms like “keystroking money” or “typing up money” are more precise than “printing money.”

The goal of QE is to elevate the price of government bonds while simultaneously lowering their yields. This strategy encourages banks to invest in riskier assets and increase lending to businesses and individuals.

QE describes a central bank purchasing “assets” from commercial banks and other private entities. While these assets are typically limited to government bonds, other forms such as mortgage-backed securities (MBS) and corporate bonds may also be included based on the central bank’s policy.

The Mechanism of Asset Purchases

For example, a U.S. pension fund may sell Treasury bonds to the Federal Reserve (Fed) and receive a deposit in return. This interaction leads to the creation of new deposits (commercial bank money) and increased reserves (central bank money).

Understanding Reserves vs. Deposits

• Reserves: The "central bank money" used for interbank transactions.
• Deposits: The "commercial bank money" held by individuals and companies and spent in the real economy.

The two primary objectives of QE are:

1. Lowering Long-Term Interest Rates: QE aims to promote borrowing and economic growth.
2. Encouraging Risk-Taking: By directing investors toward riskier assets such as stocks and non-government bonds.

QE also acts as a signaling tool, reinforcing the Fed’s guidance on future interest rates. By purchasing long-term assets, the Fed signals its commitment to maintaining lower rates for an extended period.

Despite its intentions, the newly created money often does not flow into the real (non-financial) economy. Instead, it returns to the financial sector, leading to all-time highs in both the bond and stock markets.

The Control of Long-Term Interest Rates

Central banks typically manage long-term interest rates indirectly by influencing short-term rates. However, through QE, they can attempt to directly control long-term rates. By purchasing long-term debt, such as 30-year Treasury bonds, demand increases, leading to higher prices and lower yields.

In summary, the overarching objective of QE is to boost excess reserves of banks and elevate the prices of financial assets purchased, subsequently lowering their yields.

Striking a Balance in Economic Growth

Central bankers aim to maintain a “steady” economy by promoting growth while avoiding inflation, stagnation, or recession. Key instruments for managing growth include interest rate adjustments.

The Use of QE as a Tool

When interest rates approach zero, central banks resort to quantitative easing as an alternative strategy to inject money into the financial system. By purchasing assets using electronically created money, they increase the overall liquidity and encourage lending, thereby stimulating business investment and consumer spending.