quantitative easing

What is Quantitative Easing (QE)?

💰 QE is a tool used by central banks to increase the money supply when normal policy tools (like lowering interest rates) are no longer effective.

Think of it as a bank giving a big loan to the economy to keep it moving when the usual “interest‑rate” lever is already at its lowest point.

How QE Works – Step by Step

1. Central bank announces it will buy financial assets (usually government bonds) from banks.
2. It pays for these assets by creating new bank reserves – essentially adding money to the banking system.
3. With more reserves, banks can lend more, lowering borrowing costs for businesses and households.
4. Lower borrowing costs encourage spending and investment, boosting economic activity.

Mathematically, the increase in money supply (\$\Delta M\$) can be represented as:

\$\Delta M = \text{Purchase of bonds}\$

Effects on the Economy

• 📈 Lower interest rates – cheaper loans for consumers and firms.
• 💸 Higher asset prices – stocks and real estate become more expensive.
• 📉 Currency depreciation – a weaker currency can boost exports.
• ⚖️ Inflation pressure – more money chasing the same goods can raise prices.

Example: If the Bank of England buys £100 bn of bonds, the money supply increases by £100 bn, potentially lowering the policy rate from 0.5% to 0.25%.

Risks & Criticisms

• ⚠️ Asset bubbles – too much cheap money can inflate prices beyond sustainable levels.
• 💼 Bank profitability – lower rates reduce banks’ interest margins.
• 🔁 Exit strategy – unwinding QE can be tricky and may destabilise markets.
• 🗣️ Income inequality – wealthier individuals benefit more from rising asset prices.

Exam Tips

📝 Remember the key points:

• Define QE and explain why it is used when rates are at the zero‑lower bound.
• Describe the mechanism: asset purchases → increased reserves → lower rates.
• Discuss both positive effects (stimulus, lower borrowing costs) and negative effects (bubbles, inequality).
• Use diagrams or tables to illustrate the transmission mechanism.
• Answer in clear, concise language and keep your answer within the word limit.

Quick Quiz

What would likely happen if the central bank stops QE abruptly?

1. Interest rates rise, borrowing costs increase.
2. Asset prices fall, potentially causing a recession.
3. Inflation may drop, but the economy could slow down.

Answer: All of the above – a sudden end to QE can tighten the economy.

Data Snapshot – QE in 2020