If you have been watching the news over the last few years then you will have heard the phrase, Quantitative easing. The global recession has forced many financial institutions to use this measure and this guide will tell you the basics of what you need to know.
What is Quantitative Easing?
In times of economic uncertainty governments and banks may need to implement unconventional strategies to reduce the impact. Recessions and economic downturns like the ones being experienced across the globe have forced the hand of policy makers, and Quantitative easing is one of the weapons of last resort at their disposal.
In times of economic stability a central bank will conduct its monetary policy by raising and lowering interest rates and achieves its goals through the buying and selling of government bonds to financial institutions and banks. When it collects payment s or spends it alters the amount of money in the country’s economy and also affects the price of the government bonds. That in turn affects the interest rates with the banks.
Where deflation occurs or the rate of inflation is very low the central bank may use quantitative easing to increase the amount of money in the system rather than lower the interest rate. The bank of England has recently used Quantitative easing to help the ailing British economy. The extra cash is intended to be used by the banks to assist ailing small businesses and get money moving in the system once again.
The policy can only be carried out by a central bank and as a result the Eurozone countries are unable to issue it as they have to rely on the European central banks monetary policy.
Risks of Quantitative Easing
The policy if Quantitative easing is regarded as an option of last resort due to the risks that it can generate to a country’s economy. It takes time for the QE to show an impact and if the central bank is not prepared the extra influx of money can lead to rapid inflation that can destabilise a banks plan to stabilise the economy. Another danger is that the banks, the extra money is intended for may not lend it to businesses and households effectively causing the policy to fail. The extra cash created by QE can also lead to depreciation in the currency’s value affecting exchange rates and damaging international trade.
Quantitative easing impacts the currency exchange markets by causing a country’s exchange rates to depreciate versus other currencies benefiting exporters but harming creditors.