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The information on this site does not modify any insurance policy terms in any way. The Federal Reserve typically slashes interest rates in recessions to revive an ailing economy — but in more severe crises, it might not be enough.
Quantitative easing also known as Q. Treasury and mortgage-backed securities — to push down longer-term interest rates and provide additional stimulus to the economy. The rate, however, normally only directly influences shorter-term rates, such as deposit yields and credit card rates. But when the Fed took interest rates all the way down to near-zero as the U. Quantitative easing works through open-market trading operations at the regional Federal Reserve Bank of New York.
By buying these assets, the Fed increases demand for those securities, raising prices but pushing down yields. The Fed can also purchase federal agency debt and mortgage-backed securities. That, in turn, increases the availability of credit in private markets and can help revive mortgage lending.
Semi-annual coupon payments are remitted back to the U. When those securities ultimately mature, they roll off the balance sheet, with the money all going back to the Treasury. That means it has to borrow hundreds of billions of pounds, which it does by issuing bonds. The fact that at the same time the Bank of England is buying hundreds of billions of pounds' worth of bonds helps the government to raise that money.
The Bank doesn't buy directly from the government, it buys from other investors, but its actions undoubtedly make government borrowing cheaper and easier. When the latest round of QE is complete, the Bank of England will hold well over a third of the national debt. The government also pays much less interest on bonds owned by the Bank of England than other investors - which takes further pressure off the public finances.
Most research suggests that QE helped to keep economic growth stronger, wages higher, and unemployment lower than they would otherwise have been.
As well as bonds, it increases the prices of things such as shares and property. This tends to benefit wealthier members of society who already own these things, as the Bank itself concluded in Meanwhile, younger people found it harder to buy their first homes and build up savings.
Another important side effect of QE hit pension funds. Government bond prices are used to estimate how much it will cost to provide pensions in the future. If those bond prices go up, the cost of providing future pensions rises. As a result many firms were obliged to make bigger payments into their pension schemes, reducing money available to invest elsewhere. Closer analysis reveals just how nuanced the term quantitative easing is.
For instance, Ben Bernanke , renowned monetary policy expert and chair of the Federal Reserve, draws a sharp distinction between quantitative easing and credit easing : "[Credit easing] resembles quantitative easing in one respect: It involves an expansion of the central bank's balance sheet.
However, in a pure QE regime, the focus of the policy is on the quantity of bank reserves , which are liabilities of the central bank; the composition of loans and securities on the asset side of the central bank's balance sheet is incidental.
Despite the semantics, even Bernanke admits that the difference in the two approaches "does not reflect any doctrinal disagreement. This leads to more disagreements. Whether quantitative easing works is a subject of considerable debate. There are several notable historical examples of central banks increasing the money supply.
This process is often referred to as "printing money," even though it's done by electronically crediting bank accounts and it doesn't involve printing. While spurring inflation to avoid deflation is one of the goals of quantitative easing, too much inflation can be an unintended consequence.
Germany in the s and Zimbabwe in the s engaged in what many scholars refer to as quantitative easing. In both cases, the result was hyperinflation. However, many modern scholars aren't convinced that the efforts of these countries qualify as quantitative easing.
In , the Bank of Japan increased its reserves from five trillion yen to 35 trillion yen. But again, there is debate over whether or not Japan's effort can be categorized as quantitative easing at all. Economic efforts in the United States and the United Kingdom during also met with disagreement over definitions and effectiveness. European Union countries are not permitted to engage in quantitative easing on a country-by-country basis, as each country shares a common currency and must defer to the central bank.
There is also an argument that QE has psychological value. Experts can generally agree that quantitative easing is the last resort for desperate policymakers. When interest rates are near zero but the economy remains stalled, the public expects the government to take action. Quantitative easing, even if it doesn't work, shows action and concern on the part of policymakers. Even if they cannot fix the situation, they can at least demonstrate activity, which can provide a psychological boost to investors.
Of course, by purchasing assets, the central bank is spending the money it has created, and this introduces risk. For example, the purchase of mortgage-backed securities runs the risk of default. It also raises questions about what will happen when the central bank sells the assets, which will take cash out of circulation and tighten the money supply.
As with anything market-related, perception can easily become reality. This is certainly no less true with QE. Quantitative easing attempts to treat an ailing economy with an infusion of cash. Its design follows the "less is more" model, meaning it should not be prolonged. The taper tantrum of illustrates how investors can become dependent and subject to panic attacks when just the threat of tapering occurs.
Understand the pros and cons of QE and, importantly, that it is not meant to be permanent. Know too that the jury is still out on QE as an economic cure. Enacted with caution and control it shows promise but not perfection. Finally, remember that the best economic outcome of quantitative easing is when it is no longer needed.
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