If the most controversial investment terms are rewarded, “quantitative easing” (QE) will win the highest award. Experts disagree on almost everything in this term—its meaning, its implementation history, and its effectiveness as a monetary policy tool.
The U.S. Federal Reserve and the Bank of England have used quantitative easing to fend off the financial crisis. In fact, the United States has gone through three iterations: QE, QE2 and QE3. The Bank of Japan is the first to try and has been using quantitative easing for many years, and the European Central Bank (ECB) has also used it to stimulate economic growth in the euro zone.So what’s the big deal about quantitative easing-is it really effective?
- Quantitative easing (QE) is an unconventional monetary policy used by the central bank to rapidly increase the domestic money supply in order to stimulate economic activity.
- Quantitative easing involves a country’s central bank buying long-term government bonds and other types of assets, such as mortgage-backed securities (MBS).
- After the 2008-09 financial crisis and in 2020, the Fed used quantitative easing again to respond to economic shutdowns.
- Economists tend to agree that quantitative easing is effective, but warn that too much can be a bad thing.
Quantitative Easing (QE) basis
Quantitative easing effectively enabled the central bank to substantially increase the size of its balance sheet, which also increased the amount of credit available to borrowers. To achieve this, the central bank issues new currency and uses it to purchase assets from commercial banks. These then become the new reserves held by these banks. Ideally, the asset funds received by the bank will be loaned to the borrower at an attractive interest rate. The idea is that through easier access to loans, interest rates will remain low and consumers and businesses will borrow, consume and invest.
According to economic theory, increased spending leads to increased consumption, thereby increasing demand for goods and services, promoting job creation, and ultimately creating economic vitality. Although this series of events seems to be a simple process, remember that this is an over-simplification of more complex topics.
In the United States, the Federal Reserve is the central bank of the country.
Quantitative easing (QE) challenges
A closer analysis reveals the nuances of the term quantitative easing. For example, the well-known monetary policy expert and Federal Reserve Chairman Ben Bernanke made a clear distinction between quantitative easing and credit easing:”[Credit easing] On the one hand, it is similar to quantitative easing: it involves expanding the central bank’s balance sheet. However, in a pure quantitative easing system, the focus of policy is on the amount of bank reserves, which are the central bank’s liabilities; the composition of loans and securities on the asset side of the central bank’s balance sheet is accidental. Bernanke also pointed out that the focus of credit easing is the “combination of loans and securities” held by the central bank.
Despite the semantics, even Bernanke admitted that the differences between the two methods “do not reflect any doctrinal differences.” Economists and the media basically ignore this distinction and call any effort by the central bank to purchase assets and expand its balance sheet as quantitative easing. This will lead to more disagreements.
Is quantitative easing effective?
Whether quantitative easing is effective is a controversial topic. There are several famous examples of central banks increasing the money supply in history. This process is often referred to as “money printing”, although it is done through electronic credit to a bank account and does not involve printing.
Although stimulating inflation to avoid deflation is one of the goals of quantitative easing, excessive inflation may be an unexpected consequence. Germany (1920s) and Zimbabwe (2000s) participated in what many scholars call quantitative easing policies. In both cases, the result is hyperinflation. However, many modern scholars do not believe that the efforts of these countries can be called quantitative easing.
From 2001 to 2006, the Bank of Japan increased its foreign exchange reserves from 5 trillion yen to 35 trillion yen.Most experts believe that this effort has failed. But again, there is controversy over whether Japan’s efforts can be classified as quantitative easing.
The economic efforts of the United States and the United Kingdom in 2009-10 also encountered differences in definition and effectiveness. EU countries do not allow quantitative easing on a country-by-country basis, because each country uses a common currency and must obey the central bank.
There is also a view that quantitative easing has psychological value. Experts generally agree that quantitative easing is the last resort of desperate policymakers. When interest rates are close to zero but the economy remains stagnant, the public expects the government to take action. Quantitative easing, even if it does not work, shows the actions and concerns of policy makers. Even if they can’t solve the problem, they can at least show the activity, which can provide a psychological boost for investors.
Of course, by purchasing assets, the central bank is spending the money it creates, which brings risks. For example, the purchase of mortgage-backed securities has a risk of default. It also raises questions about what happens when the central bank sells assets, which will take cash out of circulation and tighten the money supply.
Even the invention of quantitative easing is shrouded in controversy. Some people praised the economist John Maynard Keynes for proposing this concept; some cited the Bank of Japan to implement it; others cited the economist Richard Warner who coined the term (Richard Werner).
The controversy surrounding quantitative easing is reminiscent of Winston Churchill’s famous witty, “mystery within a mystery.” Of course, some experts will almost certainly disagree with this description.