Quantitative easing (QE) is an unconventional monetary policy used by some central banks to stimulate their economy.

The central bank creates money which it uses to buy government bonds and other financial assets, in order to increase the money supply and the excess reserves of the banking system; this also raises the prices of the financial assets bought (which lowers their yield).[1] Expansionary monetary policy normally involves a lowering of short-term interest rates by the central bank. However, when such interest rates are either at, or close to, zero, normal monetary policy can no longer function, and quantitative easing may be used by the monetary authorities in order to lower interest rates further out on the yield curve and further stimulate the economy.[2][3] Risks include the policy being more effective than intended or 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.

History
The original Japanese expression for "quantitative easing" (  , ry teki kin'y kanwa), was used for the first time by a Central Bank in the Bank of Japan¶s publications. The Bank of Japan has claimed that the central bank adopted a policy with this name on 19 March 2001.[5] However, 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.[6] Indeed, the Bank of Japan had for years, including as late as February 2001, claimed that "quantitative easing « is not effective" and rejected its use for monetary policy.[7] Speeches by the Bank of Japan leadership in 2001 gradually, and ex post, hardened the subsequent official Bank of Japan stance that the policy adopted by the Bank of Japan on March 19, 2001 was in fact quantitative easing. This became the established official view, especially after Toshihiko Fukui was appointed governor in February 2003. The use by the Bank of Japan is not the origin of the term "quantitative easing" or its Japanese original (ryoteki kinyu kanwa). This expression had been used since the mid-1990s by critics of the Bank of Japan and its monetary policy. Quantitative easing was used unsuccessfully by the Bank of Japan (BOJ) to fight domestic deflation in the early 2000s.[2][8][9][10] The Bank of Japan has maintained short-term interest rates at close to zero since 1999. With quantitative easing, it flooded commercial banks with excess liquidity to promote private lending, leaving them with large stocks of excess reserves, and therefore little risk of a liquidity shortage.[11] The BOJ accomplished this by buying more government bonds than would be required to set the interest rate to zero. It also bought assetbacked securities and equities, and extended the terms of its commercial paper purchasing operation.[12]

After 2007
More recently, similar policies have been used by the United States, the United Kingdom and the Eurozone during the Financial crisis of 2007±2010. Quantitative easing was used by these countries as their interbank interest rates are either at, or close to, zero.

During the peak of the financial crisis in 2008, the Federal Reserve expanded its balance sheet dramatically by adding new assets and new liabilities without "sterilizing" these by corresponding subtractions. In the same period the United Kingdom also used quantitative easing as an additional arm of its monetary policy in order to alleviate its financial crisis.[13][14][15] 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. This process has led to bonds being "structured for the ECB".[16] 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); the Bank of England applied a large haircut. During 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.[17] 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 central bank can also lend the new money to private banks or buy assets from banks in exchange for currency.[citation needed] These have the effect of depressing interest yields on government bonds and similar investments, making it cheaper for business to raise capital.[18] Another side effect is that investors will switch to other investments, such as shares, boosting their price and thus creating the illusion of increasing wealth in the economy.[17] QE can reduce interbank overnight interest rates, and thereby encourage banks to loan money to higher interest-paying and financially weaker bodies.

Amounts
The US Federal Reserve held between $700±$800 billion of Treasury notes on its balance sheet even before the recession. In late November 2008, the Fed started buying $600 billion Mortgagebacked securities (MBS).[19] By March 2009, it held $1.75 trillion of bank debt, MBS, and Treasury notes, and reached a peak of $2.1 trillion in June 2010. Further purchases were halted since the economy had started to improve. Holdings started falling naturally as debt matured. In fact, holdings were projected to fall to $1.7 trillion by 2012. However, in August 2010 the Fed decided to renew quantitative easing because the economy wasn't growing robustly. Its goal was to keep holdings at the $2.054 trillion level. To maintain that level, the Fed bought $30 billion in 2-10 year Treasury notes a month. In November 2010, the Fed announced it would increase quantitative easing, buying $600 billion of Treasury securities by the end of the second quarter of 2011.[20] The Bank of England had purchased around £165 billion of assets by September 2009 and around £175 billion of assets by end of October 2010.[21] At its meeting in November 2010, the Monetary Policy Committee (MPC) voted to increase total asset purchases to £200 billion. That programme of purchases has been completed. Most of the assets purchased have been UK government securities (gilts), the Bank has also been purchasing smaller quantities of highquality private sector assets.[22] In December 2010 MPC member Adam Posen called for a £50 billion expansion of the Bank's quantitative easing programme, whilst his colleague Andrew

Sentance has called for an increase in interest rates due to inflation being above the target rate of 2%.[23] The European Central Bank (ECB) said it would focus efforts on buying covered bonds, a form of corporate debt. It signalled initial purchases would be worth about ¼60 billion in May 2009.
[24]

The Bank of Japan (BOJ) increased the commercial bank current account balance from ¥5 trillion yen to ¥35 trillion (approximately US$300 billion) over a 4 year period starting in March 2001. As well, the BOJ tripled the quantity of long-term Japan government bonds it could purchase on a monthly basis. Most recently, in early October 2010, the BOJ announced that it would examine the purchase of $60 billion in assets. This was an attempt to push the value of the yen versus the U.S. dollar down to stimulate the local economy by making their exports cheaper; it didn't work.[25]

QE2
The expression 'QE2' has become a "ubiquitous nickname" in 2010, usually used to refer to a second round of quantitative easing by central banks.[26]

Origin of the term
The earliest use of the phrase "quantitative easing" has been attributed to the economist Dr Richard Werner, Professor of International Banking at the School of Management, University of Southampton (UK). At the time working as chief economist of Jardine Fleming Securities (Asia) Ltd in Tokyo, during his presentations to institutional investors in Tokyo in 1994.[27] Werner 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 nor on the conventional monetarist policy prescription of expanding the money supply (which Werner claimed would be ineffective).[10] Instead, Werner recommended policies such as direct purchases of non-traditional financial assets (such as purchases of commercial paper and other debt, equity instruments from companies, and direct lending to companies and the government by the central bank).[27] All of these, Werner claimed, would stimulate credit creation and hence boost the economy. Some of these policies have since been adopted by the US Federal Reserve, under the policy of "credit easing".

Process
Ordinarily, a central bank conducts monetary policy by raising or lowering its interest rate target for the inter-bank interest rate. The central bank achieves its interest rate target through open market operations ± where the central bank buys or sells short-term government bonds in exchange for cash. When the central bank disburses or collects payment for these bonds, it alters the amount of money in the economy, while simultaneously affecting the price (and thereby the yield) for short-term government bonds. This in turns affects the interbank interest rates.[28][29]

In some situations, such as with very low inflation, or in the presence of deflation, the central bank can no longer lower the target interest rate, as the interbank interest rates are either at, or close to, zero.[2][3] In such a situation, referred to as a liquidity trap, quantitative easing may be employed to further boost the amount of money in the financial system.[4] This is often considered a "last resort" to stimulate the economy.[30][31]

Steps
1. The central bank has previously targeted an extremely low rate of interest, near or at zero percent. 2. The central bank credits its own bank account with money it creates electronically.[4][32] 3. The central bank buys government bonds (including long-term government bonds) or other financial assets, from commercial banks or other financial institutions, with the newly created money.[4][32] Quantitative easing, and monetary policy in general, can only be carried out if a state controls the currency used. Countries in the eurozone for example, cannot unilaterally expand their money supply, and thus cannot employ quantitative easing. They must instead rely on the European Central Bank (ECB) to lower interest rates and to implement quantitative easing.[citation needed] There may also be other policy considerations. For example, under Article 123 of the Treaty on the Functioning of the European Union[18] and later Article 101 of the Maastricht Treaty, EU member states are not allowed to finance their public deficits (debts) by printing the money required to close the budget deficit.[4] Banks using quantitative easing, such as the Bank of England, have argued that they are increasing the supply of money not to fund government debt but to prevent deflation, and will choose the financial products they buy accordingly (for example, by not buying government bonds directly from the government).[4][18]

Effectiveness
According to the IMF, the quantitative easing policies undertaken by the central banks of the major developed countries since the beginning of the 2007-2010 Financial Crisis, have contributed to the reduction in systemic risks following the bankruptcy of Lehman Brothers. It has also contributed to the recent improvements in market confidence, and the bottoming out of the recession in the G-7 economies.[33]

Risks
Quantitative easing may cause higher inflation than desired if it is improperly used, and too much money is created.[34] It can fail if banks are still reluctant to lend money to small business and households in order to spur demands. Quantitative easing can effectively ease the process of deleveraging as it lowers yields. But in the context of a global economy, lower interest rates may contribute to asset bubbles in other economies. An increase in money supply in excess of what is required in an economy has an inflationary effect (as indicated by an increase in the annual rate of inflation). Inflationary risks are mitigated

if the system's economy outgrows the pace of the increase of the money supply from the easing. If production in an economy increases because of the increased money supply, the value of a unit of currency will increase even if there is more currency available. For example, 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 inflationary pressures would be equalized. 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 Fed always has the option of restoring the reserves back to higher levels through raising of interest rates or other means, effectively reversing the QE steps taken. On the other hand, in economies when the monetary demand is highly inelastic with respect to interest rates, or interest rates are close to zero (symptoms which imply a liquidity trap), QE can be implemented in order to further boost monetary supply, and assuming that the economy is well below potential (inside the production possibilities frontier), the inflationary effect would not be present at all, or in a much smaller proportion. The new money could be used by the banks to invest in emerging markets, commodity-based economies, commodities themselves and non-local opportunities rather than to lend to local businesses that are having difficulty getting loans.[35]

Comparison with other instruments
Qualitative easing
Professor Willem Buiter, of the London School of Economics, has proposed a terminology to distinguish quantitative easing, or an expansion of a central bank's balance sheet, from what he terms qualitative easing, 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), holding constant the composition of its assets. 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. 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. Qualitative easing is a shift in the composition of the assets of the central bank towards less liquid and riskier assets, holding constant the size of the balance sheet (and the official policy rate and the rest of the list of usual suspects). The less liquid and more risky assets can be private securities as well as sovereign or sovereign-guaranteed instruments. All forms of risk, including credit risk (default risk) are included.[36]

Credit easing

In introducing the Federal Reserve's response to the 2008-9 financial crisis, Fed Chairman Ben Bernanke was keen to distance the new programme, which he termed "credit easing" from Japanese-style quantitative easing. In his speech, he announced:

³

Our approach²which could be described as "credit easing"²resembles quantitative easing in one respect: It involves an expansion of the central bank's balance sheet. However, in a pure QE regime, the focus of policy is the quantity of bank reserves, which are liabilities of the central bank; the composition of loans and securities on the asset side of the central bank's balance sheet is incidental. Indeed, although the Bank of Japan's policy approach during the QE period was quite multifaceted, the overall stance of its policy was gauged primarily in terms of its target for bank reserves. In contrast, 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.[37]

´

This means that the central bank is still creating money to make the purchases but are not using it to buy back government debt, instead they are using it to buy private sector assets including residential mortgage-backed securities.[38][39] For example, the Federal Reserve has completed its purchase of $1.25 trillion in mortgage-backed securities (MBS) in an effort to support the sagging mortgage market. These purchases have increased the monetary base just as if they had purchased an equivalent amount of government securities.[40]

Printing money
Quantitative easing is often nicknamed "printing money" by the media.[41][42][43][44][45][46][47] However, central banks state that the use of the newly created money is different in QE. With QE, the newly created money is used for buying government bonds or other financial assets, whereas the term "printing money" usually implies that the newly minted money is used to directly finance government deficits or pay off government debt (known as "monetizing the government debt").[42] Central banks in some developed nations (e.g. UK, USA, Japan and EU) are forbidden by law to buy government debt directly from the government and must instead buy it from the secondary market.[40][48] However, many analysts would call this two-step process, selling bonds and then buying them back with newly created money, "monetizing the debt".[40] The distinguishing characteristic between QE and "monetizing debt" is that with QE, the central bank is creating money to stimulate the economy, not to finance government spending. Also, the central bank has the stated intention of reversing the QE when the economy has recovered (by selling the government bonds and other financial assets back into the market).[41] The only effective way to determine whether a central bank has monetized debt is to compare its performance relative to its stated objectives. Many central banks have adopted an inflation target. It is likely that a central bank is monetizing the debt if it continues to buy government debt when inflation is above target, and the government has problems with debt-financing.[40]

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