Quantitative Easing (QE) is a measurement central banks in Japan, the US, the UK, and Europe use to stimulate stalled economies. It is often the last resort when the conventional monetary policy of reducing the interest rate is impossible. Historically, if an economy slows down, the central bank will cut the interest rate to stimulate investment and keep the economy going. However, this will not work when the interest rate is near zero. In this case, further interest rate cuts will harm commercial banks’ operating model and make it impossible for them to finance lending activities.
By purchasing vast quantities of assets (often government bonds) from private sectors with its reserve, a central bank pumps large amounts of money into the stalled economy to stimulate investment and consumption. It has proven to increase commercial banks’ asset liquidity, improve corporate bond market conditions (Bank of England, 2010), and reduce firms’ dependencies on commercial banks to raise capital.
QE is (should only be) a short-term direct market operation from central banks. The downside is that it increases the dependency between the government and the central banks due to central banks holding more government bonds. Therefore, any potential sovereign debt crisis will affect central banks’ balance sheets.
References
- Bank of England (2010) Quantitative easing - how it works. Available from: https://youtu.be/J9wRq6C2fgo [Accessed 17 July 2022]