Quantitative easing

Quantitative easing (QE) is a form of unconventional monetary policy used by some central banks with the aim of decreasing long-term interest rates. QE increases the supply of money by increasing the excess reserves of the banking system, generally through buying of the central government's own bonds to stabilize or raise their prices and thereby lower their yield. This policy is usually invoked when the normal methods to control the money supply have failed, e.g. the bank interest rate, discount rate and/or interbank interest rate are either at, or close to, zero. The central bank then purchases financial assets, including government bonds, agency debt, mortgage-backed securities and corporate bonds, from banks and other financial institutions in a process referred to as open market operations. The purchases, by way of account deposits, give banks the excess reserves required for them to create new money, and thus hopefully induce a stimulation of the economy, by the process of deposit multiplication from increased lending in the fractional reserve banking system. Risks include the policy being more effective than intended or the risk of not being effective enough, if banks opt simply to sit on the additional cash in order to increase their capital reserves in a climate of increasing defaults in their present loan portfolio.[1] "Quantitative" refers to the fact that a specific quantity of money is being created; "easing" refers to reducing the pressure on banks.[2] However, another explanation is that the name comes from the Japanese-language expression for "stimulatory monetary policy", which uses the term "easing".[3][4] Examples of economies where this policy has been used include Japan during the early 2000s, and the United States, the United Kingdom and the Eurozone during the global financial crisis of 2007–the present, since the programme is suitable for
economies where the bank interest rate, discount rate and/or interbank interest rate are either at, or close to, zero.

Ordinarily, the central bank uses its control of interest rates, or sometimes reserve requirements, to indirectly influence the supply of money.[1] In some situations, such as very low inflation or deflation, setting a low interest rate is not enough to maintain the level of money supply desired by the central bank, and so quantitative easing is employed to further boost the amount of money in the financial system.[1] This is often considered a "last resort" to increase the money supply.[5][6] The first step is for the bank to "borrow" from the member bank reserve accounts, creating a depository liability.[4] It can then use these funds to buy investments like government bonds from financial firms such as banks, insurance companies and pension funds,[1] in a process known as "monetising the debt". The net impact on the central bank balance sheet is zero. For example, in introducing its QE programme, the Bank of England bought gilts from financial institutions, along with a smaller amount of relatively high-quality debt issued by private companies.[7] The banks, insurance companies and pension funds can then use the money they have received for lending or even to buy back more bonds from the bank. The

[10] During the global financial crisis of 2008–the present. the lending undertaken by commercial banks (excluding Swedish banks: the Riksbank does not require reserves from Swedish commercial banks) is subject to fractional-reserve banking: they are subject to a regulatory reserve requirement. Its balance sheet expanded dramatically by adding new assets and new liabilities without "sterilizing" these by corresponding subtractions. In the same period the United Kingdom used quantitative easing as an additional arm of its monetary policy in order to alleviate its financial crisis. policies announced by the US Federal Reserve under Ben Bernanke to counter the effects of the crisis are a form of quantitative easing.central bank can also lend the new money to private banks or buy assets from banks in exchange for currency. by buying government bonds not straight from the government.[8] Another side effect is that investors will switch to other investments. for example. This process . More specifically. Countries in the eurozone (for example) cannot unilaterally use this policy tool. can (but does not have to) be used as a basis for lending. but must rely on the European Central Bank (ECB) to implement it.[7] The increase in deposits from the quantitative easing process causes an excess in reserves and private banks can then.[8] The remainder. create even more new money out of "thin air" by increasing debt (lending) through a process known as deposit multiplication and thus increase the country's money supply. the institution's bank account is credited directly and their bank gains reserves. and thereby encourage banks to loan money to higher interest-paying and financially weaker bodies. but in secondary markets. for example.[11][12][13] The European Central Bank has used 12-month long-term refinancing operations (a form of quantitative easing without referring to it as such) through a process of expanding the assets that banks can use as collateral that can be posted to the ECB in return for euros. A state must be in control of its own currency and monetary policy if it is to unilaterally employ quantitative easing. a central bank buys from an institution. under QE. For example.000 created by quantitative easing the total new money created is potentially $100. such as the Bank of England. EU member states are not allowed to finance their public deficits (debts) by simply printing the money required to fill the hole. if they wish. under Article 123 of the Treaty on the Functioning of the European Union[8] and later the Maastricht Treaty. as happened. in Weimar Germany and more recently in Zimbabwe.[citation needed]: these can only be used to settle transactions between them and the central bank.000. called "excess reserves". For example a 10% reserve requirement means that for every $10.[7] QE can reduce interbank overnight interest rates. The US Federal Reserve's now out-of-print booklet Modern Money Mechanics explains the process.[1] Banks using QE.[citation needed] These have the effect of depressing interest yields on government bonds and similar investments.[1][8] History Quantitative easing was used unsuccessfully[9] by the Bank of Japan (BOJ) to fight domestic deflation in the early 2000s. When. boosting their price and thus creating the illusion of increasing wealth in the economy. and will choose the financial products they buy accordingly. which requires them to keep a percentage of deposits in "reserve".[citation needed] There may also be other policy considerations. The reserve requirement limits the amount of new money. such as shares. have argued that they are increasing the supply of money not to fund government debt but to prevent deflation. making it cheaper for business to raise capital.

[15] The BOJ accomplished this by buying more government bonds than would be required to set the interest rate to zero.g. It also bought asset-backed securities and equities. the Bank of England applied a large haircut. and extended the terms of its commercial paper purchasing operation. People who have saved money or are holding any monetary item will find its real value eroded by inflation. Only an increase in money supply in excess of what is required in an economy or monetary union has an inflationary effect (as indicated by an increase in the annual rate of inflation) by eroding the real value of each unit of the functional currency as well as the real value of the accounting unit of account. Inflation and hyperinflation have no effect on the real value of non-monetary items. Please see the discussion on the talk page.has led to bonds being "structured for the ECB". The neutrality of the style of writing in this article is questioned. Gold or shares in companies that grow during good and bad times). It can fail if banks are still reluctant to lend money to small business and households in order to spur demands. the BOJ had been maintaining short-term interest rates at close to their minimum attainable zero values since 1999. (October 2010) If devaluation of a currency is seen externally to the country it can affect the international credit rating of the country which in turn can lower the likelihood of foreign investment.[16] Risks Quantitative easing can trigger higher inflation than desired or even hyperinflation[17] if it is improperly used. Inflationary risks are mitigated if the system's economy outgrows the pace of the increase of the money supply from the easing. The real value of the capital amount of the debt on that home will decrease as the nominal number of dollars needed to settle the mortgage will remain constant and can be paid with future real value eroded dollars only in the case of fixed mortgage repayment rates. leaving them with large stocks of excess reserves. Those who own homes will see the nominal value of the home increase (while the real value of the home will most probably stay the same . and too much money is created.all else being equal) as more real value eroded dollars are needed to purchase the same home which still has the same real value. If production in an economy increases because of the . home printed money can flood abroad and spark asset bubbles in developing economies. it flooded commercial banks with excess liquidity to promote private lending. In Japan's case. Quantitative easing can effectively ease the process of deleveraging as it puts pressure on yields.[14] By comparison the other central banks were very restrictive in terms of the collateral they accept: the US Federal Reserve used to accept primarily treasuries (in the first half of 2009 it bought almost any relatively safe dollar-denominated securities). With quantitative easing. This combined with the associated low interest rates will put people who rely on their fixed incomes from fixed monetary savings in difficulty unless those savings are kept in an investment vehicle with an inherent value (e. however those who have negative savings (debt) will see the real value of that debt decline. But in the context of a global market. and therefore little risk of a liquidity shortage.

On the other hand. the Fed always has the option of restoring the reserves back to higher levels through raising of interest rates or other means. if a nation's economy were to spur a significant increase in output at a rate at least as high as the amount of debt monetized. The Great Yen Illusion: Japanese foreign investment and the role of land related credit creation. and ex post. and noted for his 1991 warning of the coming collapse of the Japanese banking system and economy (reference: Richard A. This expression had been used since the mid-1990s by critics of the Bank of Japan and its monetary policy. QE is seen as a way to increase the money supply to banks when the interest rates cannot be lowered further. was used for the first time by a Central Bank in the Bank of Japan’s publications. or a depressed money market (symptoms which imply a liquidity trap). including as late as February 2001.[18] However. QE can be implemented in order to further boost monetary supply. The use by the Bank of Japan is not the origin of the term "quantitative easing" or its Japanese original (ryoteki kinyu kanwa). 2001 was in fact quantitative easing. The risks associated with deflationary curves often outweigh the risks of inflation. in economies when the monetary demand is highly inelastic with respect to interest rates. claimed that "quantitative easing … is not effective" and rejected its use for monetary policy. Additionally. and assuming that the economy is well below potential (inside the production possibilities frontier). the additional commodities generated would offset any inflation that might occur. or in a much smaller proportion.[19] Indeed. he coined the expression in 1994 during his numerous presentations to institutional . maintaining near zero interest rates over long periods can result in deflation. effectively reversing the QE steps taken.increased money supply. the inflationary effect would not be present at all. The earliest written record of the phrase and concept of "quantitative easing" has been attributed to the economist Dr Richard Werner. Oxford Institute of Economics and Statistics Discussion Paper Series no. At the time working as chief economist of Jardine Fleming Securities (Asia) Ltd in Tokyo. the Bank of Japan had for years. Professor of International Banking at the School of Management. For example. As a practical example. rates close to zero. especially after Toshihiko Fukui was appointed governor in February 2003. and that company finds a major strike of oil. if a member bank makes a loan to a private company that develops oil and gas fields. Origin The original Japanese expression for "quantitative easing" (量的金融緩和. the value of a unit of currency will increase even if there is more currency available. University of Southampton (UK). This can only happen if member banks actually lend the excess money out instead of hoarding the extra cash. During times of high economic output. the inflationary pressures would be equalized. hardened the subsequent official Bank of Japan stance that the policy adopted by the Bank of Japan on March 19. ryōteki kin'yū kanwa). 1991. 129). The Bank of Japan has claimed that the central bank adopted a policy with this name on 19 March 2001. the Bank of Japan's official monetary policy announcement of this date does not make any use of this expression (or any phrase using "quantitative") in either the Japanese original statement or its English translation. Werner. This became the established official view.[20] Speeches by the Bank of Japan leadership in 2001 gradually.

Werner argues that the Bank of Japan’s usage of his expression ‘quantitative easing’ may be misunderstood. as too few listeners or readers would be familiar with it and alternative expressions were associated with flawed or failed policy prescriptions. Many of these policies have recently been adopted by the US Federal Reserve under Chairman Bernanke. among others. in the title of an article published on September 2. through the process of credit creation. The name implies a pun on the famous ship RMS Queen Elizabeth 2 . which more accurately describe its adopted policy at the time.[3] In his subsequent writings. However. purchases of commercial paper (CP) and other debt.[3] Instead. he often chose not to use it initially or in the titles of articles. expanding bank reserves or boosting deposit aggregates such as M2+CD—all of which Werner also claimed would be ineffective). While suggesting it was adopting the policy suggested by a leading critic. ‘expansion of bank reserves’ or.investors in Tokyo. or 20% of annual Japanese GDP.Richard Werner is a professor of International Banking at the University of Southampton. including his bestselling book on the Bank of Japan (Princes of the Yen. through a number of measures.e. He thus recommended as a solution policies such as direct purchases of non-performing assets from the banks by the central bank. ‘money supply expansion’. Werner's comments in this CNBC program it is apparent that the reason why he employed the expression was because he argued that the policy that . simply. Sharpe. from Prof. under the expression of "credit easing" (see below). as well as stopping the issuance of government bonds to fund the public sector borrowing requirement and instead having the government borrow directly from banks through a standard loan contract.[21] He estimated at the time that the incipient bad debt problem of the Japanese system (i.[21] According to its author. However. which Werner had predicted would fail. because commercial banks are the main producers of the money supply. Werner preferred to coin a new phrase.[23] QE2 The expression 'QE2' has become a "ubiquitous nickname" in 2010. the Bank of Japan implemented the standard monetarist expansion of bank reserves and high powered money. Werner argued. usually used to refer to a second round of quantitative easing by central banks.[22] All of these. M. Werner claimed. 1995 in the Nihon Keizai Shinbun (Nikkei).[24] It was first employed by Richard Werner in a live CNBC program on 22 September 2009. including future bad debts) amounted to about ¥100 trillion.[19] It is not obvious why the Bank of Japan chose to use Mr Werner’s expression. and not the already existing and widely used expressions ‘expansion of high powered money’. would stimulate credit creation and hence boost the economy.g. he used this phrase in order to propose a new form of monetary stimulation policy by the central bank that relied neither on interest rate reductions (which Werner claimed in his Nikkei article would be ineffective) nor on the conventional monetarist policy prescription of expanding the money supply (e. The subsequent slowdown in bank credit extension was the major problem. the port in which the ship was based through most of its history. and his 2005 book New Paradigm in Macroeconomics: Solving the Riddle of Japanese Macroeconomic Performance. it was necessary and sufficient for an economic recovery to boost ‘credit creation’. expanding high powered money. through "printing money". while Werner used and explained the concept of credit creation in his speeches and articles. as well as equity instruments from companies by the central bank. who was familiar with the debate on Japanese monetary policy. It is also. and that this had increased banks’ risk aversion. Palgrave Macmillan). E. direct lending to companies and the government by the central bank.

from what he terms qualitative easing.[26] Credit easing In introducing the Federal Reserve's response to the 2008-9 financial crisis.[27] . productive and hence non-inflationary growth. In contrast. 'true quantitative easing' was needed. which are liabilities of the central bank. This required a second attempt by central banks. the composition of loans and securities on the asset side of the central bank's balance sheet is incidental. An almost equivalent definition would be that quantitative easing is an increase in the size of the balance sheet of the central bank through an increase in its monetary liabilities that holds constant the (average) liquidity and riskiness of its asset portfolio. holding constant the composition of its assets. although the Bank of Japan's policy approach during the QE period was quite multifaceted. namely an expansion in productive credit creation. Werner would consider the 'wrong type' of QE. or the process of a central bank adding riskier assets onto its balance sheet: Quantitative easing is an increase in the size of the balance sheet of the central bank through an increase it is [sic] monetary liabilities (base money). Indeed. including credit risk (default risk) are included. the expression is today mainly used to refer to a second round of what Prof. "a kind of QE2". Asset composition can be defined as the proportional shares of the different financial instruments held by the central bank in the total value of its assets. Comparison with other instruments Qualitative easing Willem Buiter has proposed a terminology to distinguish quantitative easing. which he termed "credit easing" from Japanese-style quantitative easing. the overall stance of its policy was gauged primarily in terms of its target for bank reserves. the Federal Reserve's credit easing approach focuses on the mix of loans and securities that it holds and on how this composition of assets affects credit conditions for households and businesses. All forms of risk. In his speech.[25] Meanwhile. he announced: “ Our approach—which could be described as "credit easing"—resembles quantitative easing in one respect: It involves an expansion of the central bank's balance sheet. holding constant the size of the balance sheet (and the official policy rate and the rest of the list of usual suspects). Instead. he argued. the focus of policy is the quantity of bank reserves. and hence likely to remain insufficient to deliver sustainable.was not 'true' quantitative easing as originally defined by him. Qualitative easing is a shift in the composition of the assets of the central bank towards less liquid and riskier assets.was being called 'quantitative easing' by central banks and in the media . Fed Chairman Ben Bernanke was keen to distance the new programme. or an expansion of a central bank's balance sheet. in a pure QE regime.base money expansion and open market purchases of securities from banks . However. The less liquid and more risky assets can be private securities as well as sovereign or sovereign-guaranteed instruments.

It gets it by issuing U./Director. is borrowing money from China. But the government can't simply spend more than it takes in without getting the money from somewhere. or that China is buying U. Investopedia explains Quantitative Easing Central banks tend to use quantitative easing when interest rates have already been lowered to near 0% levels and have failed to produce the desired effect. When the national government spends more than it collects in tax revenue in a single year. 2010 2:41 PM CST If you follow the economic headlines. . government was borrowing money from you-or. debt.S. the U. "Quantitative easing"-AKA printing money By Robert Carreira. just like China does. savings bond. the U. a term you've probably encountered over the past few weeks is "quantitative easing.S. Ph.S.D. Treasury securities. Put another way. When you hear that the U.S. December 1.S.S. Federal Reserve buys them. and notes. there is still a fixed amount of goods for sale. what that means is China is buying U. it's referred to as a budget deficit. while the investor collects interest on the securities. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. it's referred to as the national debt. put another way.S. the U. government buys its own debt. Treasury securities-treasury bills. If you've ever owned a U. Investors buy the securities and the government then has money to spend.S.Quantitative Easing What Does Quantitative Easing Mean? A government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market.S. Treasury securities. Department of Treasury issues the securities and the U. debt." The term refers to the Federal Reserve's purchase of U. In essence. When you add up the deficits year after year. Center for Economic Research Published: Wednesday.S.S. bonds. This will eventually lead to higher prices or inflation. The major risk of quantitative easing is that although more money is floating around. you bought U.

S. 21 meeting of the Federal Open Market Committee. But when the economy fully recovers. it doesn't really print it. the excess money presents a serious inflation risk. although the recovery has been weak. this causes an overall increase in the demand for securities. Since treasury prices and yields are inversely related (as one goes up the other goes down). it buys U. There are concerns with further quantitative easing. but it creates it electronically out of thin air-this decreases the value of money. dollar on the foreign exchange market. Gold prices have been driven to historic highs due to long-term inflationary fears. Banks are currently awash with excess reserves-to the tune of about $1 trillion-but remain cautious about lending after the loose money debacle that led to the current economic woes.S. This increase in the supply of lendable funds lowers the rates bank charge for borrowing. it helps U. When the Fed buys securities from commercial banks. the economy is moving in the right direction and now is the time to focus on the long-term. this doesn't present an immediate problem. This means winding down the stimulus efforts.When the Fed engages in quantitative easing. debt. For most of this year. inflation has been below the Fed's comfort zone and some economists have worried the economy might see deflation. or purchases of U. Another concern with quantitative easing is that the money infused into the banking system will simply be hoarded by banks. debt. When the Fed buys government securities. further exacerbating the inflation problem. and to help fight deflation. In the shorter term. Critics of further quantitative easing argue that. This has been the case with the Fed's previous efforts to increase banks' reserves to spur lending. quantitative easing lowers the value of the U.S. withdrawing the . which drives up their prices.S. With inflation currently at low levels. As the government prints money to buy securities-well. driving up the price of imports. There are two primary motivators: to help lower interest rates in the hopes of spurring economic activity. which the banks can then loan out. A related concern is that another round of quantitative easing will fuel the current commodity bubble. One is the looming threat of inflation. One of the outcomes is that quantitative easing helps lower interest rates. including oil. and not loaned out. which is declining prices. exports since it makes them less expensive on the world market. Deflation is bad because lower prices discourage business expansion and hiring. this takes the securities off the balance sheets of the banks and replaces them with reserves. On the positive side. the Fed hinted it intends to step up its quantitative easing. At the Sep. Further saturating the credit markets with cash seems unlikely to increase lending significantly and will make it more difficult to withdraw the stimulus when the time comes. this puts downward pressure on interest rates.

.massive inflows of cash that were pumped into the banking system. and balancing the federal budget.

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