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Definition & Explanation Of Quantitative Easing

Definition & Explanation Of Quantitative Easing

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What is ‘QE (Quantitative Easing)’?

QE, Quantitative Easing in full, is a monetary policy considered to be unconventional. When implemented, the government, through the central bank, buys government securities with the aim of raising money supply and lowering interest rates. To enhance liquidity and the lending rate of commercial banks, QE raises the supply of money, effectively floods them with capital. This policy may be considered when prevailing interest rates approach or reach zero; it does not call for the printing of new bills.

Analyzing QE Bit By Bit

The authorities regulate money supply by purchasing or selling government securities. The government usually purchases government bonds to spur economic activity when dips are experienced. The effect is to increase the supply of money and decrease short-term interest rates. However, as interest rates get closer to zero, the policy loses its effectiveness; monetary authorities are then forced to turn to other methods to spur economic growth. Some alternatives monetary authorities can turn to in a bid to force banks to lend more include targeting private the assets owned by the private sector and commercial banks. It’s worth mentioning that the abbreviation QE is commonly used to refer to quantitative easing.

Disadvantages Of QE

Increasing money supply faster than the economy can absorb it can result in inflation. Such a scenario arises where the increase in money is not accompanied by a similar increase in the supply of products on the market.

Since monetary authorities, the central bank to be specific is autonomous from the government, it cannot force commercial banks to increase the rate at which they lend the additional money it supplies when implementing this monetary policy. Advancing money to commercial banks does not have any effect on the economy if they hold it instead of advancing loans to consumers and businesses.

QE may also impact the price that residents have to pay for imports. This policy usually causes the implementing country’s currency to lose value. Although this is great for exports, it translates into higher-priced imports. This effect can have an adverse effect depending on the country under consideration.

Illustration

Although QE is looked upon as an unconventional policy, it has been used severally in the recent past. A perfect example is the repeated application by the United States Federal Reserve bank after the credit crisis experienced during the period between 2007 and 2008. The European Central Bank and The Bank of Japan followed suits and implemented the policy afterward.

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