Quantitative easing (QE ) is an unconventional monetary policy used by central banks to stimulate the economy when interest rates are close to zero and traditional methods (such as cutting key interest rates) are no longer sufficient. This policy mainly involves the massive purchase of financial assets, notably government bonds and sometimes private asset-backed securities, to inject liquidity into the economy.

How does QE work?

QE works by increasing the money supply available in the financial system. Here are the main steps in the process:

1. Asset purchase: The central bank, such as the US Federal Reserve (Fed), the European Central Bank (ECB), or the Bank of England, buys government bonds or other financial securities on the financial markets. These purchases are generally financed by the creation of electronic money.
2. Liquidity injection: By purchasing these securities, the central bank increases the reserves of the commercial banks holding them. This increases the amount of liquidity available in the banking system, facilitating credit to businesses and households.
3. Lower bond yields: The central bank’s massive purchase of bonds raises their price, which in turn lowers the yields (interest rates) on these bonds. Lower interest rates make borrowing cheaper for businesses and consumers, stimulating credit demand, investment and consumption.
4. Stimulating economic growth: By encouraging banks to lend more and at lower rates, QE aims to stimulate domestic demand, boost business investment and encourage household consumption. This helps to boost economic activity, particularly in times of recession or slow growth.

Why do central banks use QE?

QE is mainly used when traditional monetary policy tools, such as interest rate cuts, are no longer effective. When interest rates are close to zero (or even negative), central banks can no longer use lower rates to stimulate the economy. QE is then a complementary measure to support growth and combat the risks of prolonged recession or deflation.

EQ objectives are generally as follows:

• Stimulating the economy: By increasing the amount of money in circulation and reducing financing costs, QE aims to stimulate economic activity.
• Combating deflation: By injecting liquidity into the economy, QE can prevent a generalized fall in prices (deflation), which could curb consumption and investment.
• Supporting financial markets: QE also helps stabilize financial markets by increasing demand for financial assets, thereby supporting prices and reducing volatility.

Examples of EQ programs

1. US Federal Reserve (Fed): The Fed launched several QE programs after the 2008 financial crisis. Between 2008 and 2014, it purchased trillions of dollars worth of government bonds and mortgage-backed securities to support the US economy.
2. European Central Bank (ECB): The ECB launched its own QE program in 2015 to combat low inflation and support economic growth in the eurozone. The program involved the purchase of member countries’ government bonds and private assets.
3. Bank of Japan (BoJ): The BoJ has been using QE since the 2000s to combat economic stagnation and deflation in Japan. It has carried out programs to purchase government bonds, private securities and even equities.

Advantages of EQ

• Stimulating the economy: QE can boost the economy by reducing interest rates, encouraging credit and supporting consumption and investment.
• Reducing the risk of deflation: By injecting money into the economy, QE can help prevent a generalized fall in prices.
• Stabilizing financial markets: By purchasing financial assets, the central bank supports asset prices and helps reduce market volatility, particularly in times of crisis.

Criticism and risks of QE

1. Excessive inflation: One of the main risks of QE is that it could lead to excessive inflation if too much liquidity is injected into the economy. However, since the financial crisis of 2008, fears of excessive inflation have rarely materialized.
2. Increased inequality: QE can have the side-effect of boosting financial asset prices, which in turn benefits investors and wealthy households, thereby reinforcing economic inequality.
3. Asset bubbles: By artificially lowering interest rates and supporting asset prices, QE could create speculative bubbles in financial markets such as equities, real estate or bonds, which could trigger future crises.
4. Dependence on QE: Economies can become dependent on QE, making it difficult to exit this policy. A reduction in asset purchases or a rise in rates could lead to financial market turbulence and an economic slowdown (the so-called “taper tantrum” effect).