The Role of Quantitative Easing in Finance

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Quantitative easing is a monetary policy of the central bank, which is used when the central bank has already set the interest rate to zero or almost. It is meant to promote the bank’s expansionary monetary policy.

In this case, the central bank may try to purchase securities such as government securities, and continue to provide the economy with more money.

In some cases, quantitative easing is identified as printing money, even though in reality the reserve bank produces it by boosting credit in its own bank account. The procedure of buying financial assets with ex-nihilo funds is also known as open market operations.

Such introduction of new money is intended to prompt the rise in money supply on the grounds of deposit multiplication, thus reducing the cost of borrowing which in turn stimulates the economy.

Although, the risk lies with financial institutions which may still be unwilling to lend regardless of increases in deposits, or the policy may fall short resulting in hyperinflation.

The aim of quantitative easing pertains to increasing the reserves in the bank’s balance sheet. However, with the quantitative easing, the funds are not physically printed, instead the M3 money supply is increased significantly. The associated risk is a possible hyperinflation.

The central banks of the United States, Britain, Japan and some emerging markets operate quantitative easing with the International Monetary Fund (IMF), as they directly purchase government securities or securities guaranteed by government.

Since March 6, 2009 the Bank of England operates quantitative easing. Initiatially, seventy five billion pounds was pumped into the market, also meant for the purchase medium and long term government bonds.

The objective of quantitative easing and the procedure of deposit multiplication relates to the increase of the sum of money released into circulation due to an rise in credit. Thereby, boosting the flow of money in the economy through increased spending, however the traditional route to achieving this goal is through the setting of interest rates.

Quantitative easing only works in the event that the usual procedure of boosting money supply by cutting interest rates does not yield satisfactory results. It is viewed as a risky strategy that could spark higher inflation than intended, in the event that it is improperly implemented.

Some sections contend that such an outcome is minimized if the reserve bank applies quantitative easing stringently to relieve credit markets. In which case the creation of money for redeeming government debts has the propensity to spark hyperinflation.

 

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