Quantitative easing (QE) can have different and conflicting definitions. But essentially, it is a market operation (carried out by central banks) that increases liquidity and inflation with the supposed intention of stimulating a country's economy by encouraging businesses and consumers to borrow and spend more.


How it works?

Typically, the operation consists of the central bank injecting money into the economy by purchasing securities (such as stocks, bonds, and treasury assets) from the government or commercial banks.

Central banks add to the reserve funds of these member banks (which are held under the fractional reserve banking system) by providing new credit. Since the new loan is not backed by a commodity or anything of physical value, QE essentially creates money out of thin air.

Therefore, the goal of QE is to increase the supply of money, making it more accessible, stimulating economic activity and growth. The idea is to keep interest rates low, stimulating lending to businesses and consumers, bolstering confidence in the overall economy. However, in practice, QE does not always work, and it is actually a very controversial move.

QE is a relatively new expansionary monetary policy. Some scholars believe its first real use was (controversially) in the late 1990s by the Japanese central bank (Bank of Japan). This is a rather controversial event as economists are still debating whether there was QE in Japan or not. Since then, several other countries have implemented QE in an effort to minimize their economic problems.


Reasons to Use Quantitative Easing

QE was designed to solve problems that arose when the modern banking system was unable to prevent a recession. The main goal of QE is to increase inflation (to avoid deflation), and adjusting interest rates is one of the main tools that central banks use to control inflation. When borrowing and financial activity slow, a country's central bank may cut rates to make banks more open to lending. Conversely, when things are going too loose, when spending and borrowing are approaching risky levels, a higher interest rate can act as a kind of stop loss.


Is Quantitative Easing Effective?

Shortly after the end of the 2008 financial crisis, the International Monetary Fund (IMF) published a paper arguing that QE was an effective unconventional monetary policy. The analysis included five major central banks: the US Federal Reserve, the European Central Bank, the Bank of England, the Bank of Canada and the Bank of Japan.

Each institution employed a unique strategy, but most dramatically increased overall market liquidity. The report argues that the interventions implemented by central banks were successful and that increased liquidity was necessary to avoid a protracted economic crisis and collapse of the financial system.

However, QE does not always work effectively and is highly dependent on the premises and strategy. Many countries have experimented with the use of QE (or other similar approach) which has not produced the desired results. If not managed correctly, the process of introducing money into the economy and lowering interest rates can lead to unexpected and undesirable results. Below we list some potential advantages and disadvantages.


Potential Benefits and Positive Impact

  • More lending: Due to the increase in funds due to asset purchases by the central bank, banks should be encouraged to issue loans.

  • Increased borrowing: Consumers and businesses are more likely to take on new debt when interest rates are low.

  • More spending: Consumers will increase their spending due to all the new credit and borrowing that brings in more money. With lower interest rates.

  • Job Growth: As businesses gain access to more capital through debt and sell more due to increased consumer spending, they have to expand and hire more employees.


Potential Disadvantages and Negative Consequences

Many experts have expressed concern that QE is a kind of postponement of solutions to larger structural problems that will ultimately lead to a deterioration of the economy. Some potential disadvantages:

  • Inflation: An increase in the money supply caused by QE naturally creates inflation. Product competition will increase due to the large circulation of money, but not an increase in the supply of goods. The higher the demand, the higher the prices. If not properly controlled, the rate of inflation rising inflation can quickly lead to hyperinflation.

  • Non-forced lending: In QE, commercial banks must use the money they receive from the central bank to make more loans. But this process does not oblige them to do so. For example, when QE was initially implemented in the US after the 2008 financial crisis, many banks kept their newfound wealth to themselves rather than spreading it around.

  • Lots of debt: Increasing the benefits of borrowing can lead businesses and consumers to borrow more than they can afford, which can have negative economic consequences.

  • Impact on other investment vehicles: The bond market often reacts negatively to the sudden changes and lack of stability that is quite common after QE.


Examples

Some countries whose central banks have used Quantitative Easing:

  • Bank of Japan: 2001-2006 and 2012 (Abenomics).
    QE did not reduce their financial problems. The Japanese yen weakened against the US dollar and import costs rose.

  • United States: 2008-2014.
    The US implemented three rounds of QE to address the housing crisis and subsequent recession. The economy has recovered, but it is quite debatable whether this was due to QE or not. In comparison with Canada, which did not use QE banking practices, it does not show any noticeable differences.

  • European Central Bank: 2015-2018.
    Europe has had some setbacks, with stable inflation, falling unemployment and a strong economy in 2017, but it is still coping with uninspiring wage growth and rising interest rates.


Conclusion

As an unconventional monetary strategy, QE may have helped some economies recover, but it is certainly a highly controversial strategy, as is this conclusion. Most of the potential risks, such as hyperinflation and excessive debt, have not yet occurred anywhere, but some countries that have used QE have experienced high currency instability and problems in economic sectors and markets. The long-term consequences are not clear enough, and the results of QE can be quite different depending on the context.