Table of Сontents
- What Is Quantitative Easing (QE)?
- How Does Quantitative Easing Work?
- Goals of Quantitative Easing
- Does Quantitative Easing Cause Inflation?
- Benefits & Concerns of Quantitative Easing
- Qualitative Easing
- U.S. Historical Examples of QE
- How Quantitative Easing Impacts Investors
- Bottom Line
A monetary policy tool used to boost economic activity is quantitative easing. In an effort to boost the money supply, ease credit restrictions, and lower interest rates, the central bank makes a significant number of securities purchases over time. Learn more about QE and the potential market effects.
What Is Quantitative Easing (QE)?
When it comes to lowering interest rates and boosting the economy, the Federal Reserve has a number of options at its disposal. People can:
- Reduce the overnight interest rate at which the Federal Reserve will lend money to commercial banks.
- Reduced reserve requirements would enable banks to increase lending.
Short-term interest rates are directly impacted by both of these. The Fed can make large-scale acquisitions of securities like Treasury Bonds to directly affect long-term interest rates.
When the Fed buys assets, it increases the value of long-term bonds while also increasing the money supply, which lowers longer-term interest rates. The availability of more money at lower interest rates encourages spending by people and businesses, which fosters expansion.
How Does Quantitative Easing Work?
The Fed will buy a lot of assets from financial institutions that are the main dealers in government securities as part of quantitative easing. The purchases are made feasible by the Fed “printing money” on its balance sheet in the form of fresh bank reserves.
The results of this are as follows:
- It gives financial organizations more capital, which they may use to provide loans to individuals and companies or acquire other assets.
- As the financial system becomes more liquid, new business ventures are encouraged, and consumer confidence rises.
- Bond purchases often result in upward pressure on bond prices, which lowers long-term interest rates.
- Investors put more of their money into riskier products, primarily stocks, when long-term interest rates decrease.
Goals of Quantitative Easing
Quantitative easing thus serves multiple purposes:
- Long-term interest rates are under pressure to decline as a result.
- It boosts bank liquidity and the money supply.
- It aids in sustaining financial markets.
- Both consumers and companies gain confidence in the economy as a result
Although it is widely agreed that QE is effective in attaining these objectives, the Fed must employ it with caution since it may have unfavorable side effects like higher inflation..
Does Quantitative Easing Cause Inflation?
While QE has during the previous 14 years or so given the economy the boost it needed to avoid falling into a recession, it is seen as a temporary help rather than a long-term solution.
The main justification for this is the worry that an excessive amount of easing may cause inflation, which is frequently a result of having more money in circulation. According to a large number of economic regulators and experts, the effective monetary policy aims to temper economic fluctuations in an effort to preserve a long-term equilibrium.
Benefits & Concerns of Quantitative Easing
Quantitative easing (QE), while generally seen as a helpful tool for carrying out monetary policy, is not without dangers or issues. The following list includes the potential benefits and downsides of quantitative easing.
Benefits
- Increases money supply: The amount of money in circulation rises as a result of asset purchases.
- Reduces long-term interest rates: Long-term bond purchases drive up bond prices and drive down interest rates..
- Instills more confidence in the economy: QE is an indication that the Fed is preventing a recession by acting.
Concerns
- Can lead to inflation: Inflation can occur as a result of artificial money supply growth.
- Can lead to asset bubbles: Asset purchases can trigger more public purchases, which could result in asset bubbles.
- Success is difficult to prove: Academic research on the effectiveness of QE is inconsistent. Since the first QE took place in November 2008, there isn’t much of a sample size from which to draw conclusions.
- Potential inequality: Price increases on assets often benefit those who can afford to own them the most.
Qualitative Easing
Qualitative easing is a similar, but less frequent, monetary policy measure to quantitative easing. Purchasing poorer quality (i.e., “troubled”) assets while simultaneously selling higher quality assets is known as qualitative easing. The QE asset acquisitions financed by money creation may or may not go along with this.
During the 2008 financial crisis, the Troubled Asset Relief Program (TARP) introduced qualitative easing (TARP). It was created to buy troubled assets, such as mortgage-backed securities, that may have caused a chain reaction and other financial institutions that were otherwise sound to fail.
U.S. Historical Examples of QE
2008 Great Recession
The Fed, led by Chairman Ben Bernanke, employed QE to combat the financial crisis in 2008 and the ensuing recession, buoyed by the success of QE in Europe and Japan. Under a large QE program that included three distinct rounds and more than $4 trillion in purchases between 2009 and 2014, the Fed bought assets worth more than that amount.
The initiative, which was a first of its sort in the US, was largely credited with saving the financial system from a catastrophic collapse and helping the nation get through the crisis.
2020 COVID-19 Pandemic
The Fed used QE once more in reaction to the financial hardship brought on by the COVID-19 epidemic and the widespread closure of enterprises throughout the world, building on the effectiveness of QE during the previous ten years. The COVID recession in 2020 was helped by QE, and the rebound in the financial markets during the second part of the year was very robust.
How Quantitative Easing Impacts Investors
Massive QE asset purchases by the Fed will generally have a strong positive impact on the markets. That, in turn, can certainly be a positive for investors who own assets in those markets. QE, however, is a reactionary strategy, so asset prices will likely have declined prior to the implementation of QE and initial gains may only serve to offset prior losses.
Investors may find new opportunities that result from announced QE programs, but the Fed does not always announce its intentions in this regard, making it difficult for investors to identify when, and in which markets, QE is being implemented.
For long-term investors, perhaps the greatest advantage of QE is the confidence to remain invested, rather than panic out when a crisis unfolds.
Bottom Line
Quantitative Easing: What Is It?
Accessed on May 12, 2022
Richard Lehman penned the article
Author: Jason Kirsch, CFP
Summary of Contents
Quantitative Easing: What Is It?
The Function of Quantitative Easing
Quantitative Easing’s objectives
Inflation: Does Quantitative Easing Cause It?
The advantages and drawbacks of quantitative easing
Quality Improvement
American Historical QE Examples
What Effects Does Quantitative Easing Have on Investors
To sum up
A monetary policy tool used to boost economic activity is quantitative easing. In an effort to boost the money supply, ease credit restrictions, and lower interest rates, the central bank makes a significant number of securities purchases over time. Learn more about QE and the potential market effects.
Illustration from the book Quantitative Easing
Getty Images via Vitezslav Vylicil/iStock
Quantitative Easing: What Is It?
When it comes to lowering interest rates and boosting the economy, the Federal Reserve has a number of options at its disposal. People can:
Reduce the overnight interest rate at which the Federal Reserve will lend money to commercial banks.
Reduced reserve requirements would enable banks to increase lending.
Short-term interest rates are directly impacted by both of these. The Fed can make large-scale acquisitions of securities like Treasury Bonds to directly affect long-term interest rates.
When the Fed buys assets, it increases the value of long-term bonds while also increasing the money supply, which lowers longer-term interest rates. The availability of more money at lower interest rates encourages spending by people and businesses, which fosters expansion.
The Function of Quantitative Easing
The Fed will buy a lot of assets from financial institutions that are the main dealers in government securities as part of quantitative easing. The purchases are made feasible by the Fed “printing money” on its balance sheet in the form of fresh bank reserves.
The results of this are as follows:
It gives financial organizations more capital, which they may use to provide loans to individuals and companies or acquire other assets.
As the financial system becomes more liquid, new business ventures are encouraged, and consumer confidence rises.
Bond purchases often result in upward pressure on bond prices, which lowers long-term interest rates.
Investors put more of their money into riskier products, primarily stocks, when long-term interest rates decrease.
Quantitative Easing’s objectives
Thus, quantitative easing has a number of uses:
Long-term interest rates are under pressure to decline as a result.
It boosts bank liquidity and the money supply.
It aids in sustaining financial markets.
Both consumers and companies gain confidence in the economy as a result.
Although it is widely agreed that QE is effective in attaining these objectives, the Fed must employ it with caution since it may have unfavourable side effects like higher inflation.
Inflation: Does Quantitative Easing Cause It?
While QE has during the previous 14 years or so given the economy the boost it needed to avoid falling into a recession, it is seen as a temporary help rather than a long-term solution.
The main justification for this is the worry that an excessive amount of easing may cause inflation, which is frequently a result of having more money in circulation. According to a large number of economic regulators and experts, the effective monetary policy aims to temper economic fluctuations in an effort to preserve a long-term equilibrium.
The advantages and drawbacks of quantitative easing
Despite being accepted as a beneficial instrument for implementing monetary policy, quantitative easing (QE) is not without risks or problems. The possible advantages and drawbacks of quantitative easing are outlined below.
Benefits
Increases the supply of money: Purchasing assets increases the quantity of money in use.
lowers long-term interest rates: Buying long-term bonds pushes bond prices up and lowers interest rates.
Increases economic confidence: QE shows that the Fed is taking steps to avoid a recession.
Concerns
Inflation may result in artificially increasing the money supply.
Can result in asset bubbles: The public may continue to buy assets after initial purchases, which could result in asset bubbles.
Proving success is challenging since academic research on the effectiveness of QE is conflicting. Since the first QE took place in November 2008, there isn’t much of a sample size from which to draw conclusions.
Potential for inequality: People who are well off enough to possess the assets to gain disproportionately from increases in asset prices.
Quality Improvement
Qualitative easing is a similar, but less frequent, monetary policy measure to quantitative easing. Purchasing poorer quality (i.e., “troubled”) assets while simultaneously selling higher quality assets is known as qualitative easing. The QE asset acquisitions financed by money creation may or may not go along with this.
During the 2008 financial crisis, the Troubled Asset Relief Program (TARP) introduced qualitative easing (TARP). It was created to buy troubled assets, such as mortgage-backed securities, that may have caused a chain reaction and other financial institutions that were otherwise sound to fail.
American Historical QE Examples
Great Recession of 2008
The Fed, led by Chairman Ben Bernanke, employed QE to combat the financial crisis in 2008 and the ensuing recession, buoyed by the success of QE in Europe and Japan. Under a large QE program that included three distinct rounds and more than $4 trillion in purchases between 2009 and 2014, the Fed bought assets worth more than that amount.
The initiative, which was a first of its sort in the US, was largely credited with saving the financial system from a catastrophic collapse and helping the nation get through the crisis.
Pandemic COVID-19 in 2020
The Fed used QE once more in reaction to the financial hardship brought on by the COVID-19 epidemic and the widespread closure of enterprises throughout the world, building on the effectiveness of QE during the previous ten years. The COVID recession in 2020 was helped by QE, and the rebound in the financial markets during the second part of the year was very robust.
What Effects Does Quantitative Easing Has on Investors
Markets will often be strongly benefited by the Fed’s large-scale QE asset purchases. In turn, that may undoubtedly be advantageous for investors who have assets in such areas. However, as QE is a reactive technique, asset values will probably have fallen before it is put into place, and any initial gains could only be used to make up for earlier losses.
Although the Fed does not always make its intentions clear in this respect, it can be challenging for investors to determine when and in which markets QE is being implemented. Investors may discover fresh possibilities as a result of QE initiatives that have been publicly publicized.
Perhaps the biggest benefit of QE for long-term investors is the assurance to stay invested rather than sell out when a crisis develops.
To sum up
Only twice in the previous 14 years has the Fed deployed quantitative easing, making it a relatively new weapon in its toolbox for monetary policy? Although there are hazards to the method that may not yet be completely obvious or quantified, the outcomes so far seem to be good. For instance, the QE employed during the COVID-19 epidemic may have led to the equity markets’ excessive inflation throughout 2020–2022, which in turn may have influenced the present collapse in mid–2022.
As a result, the Fed is probably currently modifying the technique’s use and reviewing the outcomes. However, there is widespread support for the move, which is viewed as a legitimate safeguard against even more severe damage during difficult economic times.
