Quantitative easing is the policy where the government purchases bonds and financial instruments by printing money in order to stimulate the economy. Quantitative easing proves to be a monetary policy that the Federal Reserve and other central banks around the world utilize in order to grow the money supply. They do this by boosting the cash reserves in the banking system. This is accomplished via purchasing the government’s issued bonds in order to raise their prices.
Since prices and interest rates of bonds move inversely, higher bond prices lead directly to lower long term interest rates. Quantitative easing is commonly employed only after other more traditional means of dominating the supply of money have not worked. These other methods involve lowering discount rates, bank interest rates, and even interbank interest rates to around zero.
Once these traditional means have failed to stimulate the economy, the Fed then steps into the market and directly buys financial instruments. The assets that they purchase include agency debt, government bonds, corporate bonds, and mortgage backed securities, which they purchase from banks and institutions. This entire process is called open market operations. By depositing electronically created money into the banks’ accounts, the banks gain additional reserves that permit them to create still additional money from thin air. The Fed hopes that this multiplication of deposits accomplished through the fractional reserve banking system will allow greater amounts of loans to be made to businesses and individuals in order to stimulate the economy.
This quantitative easing policy is not without its risks. It could be too effective or not sufficiently effective, should banks decide to hoard their extra money to boost their capital reserves. This is particularly the case in an environment of rising defaults in the banks’ mortgage and other types of loans’ holdings.
Recent examples of quantitative easing abound. This subtle form of printing money became more and more common as the financial crisis of 2007 to 2010 grew worse. In these years, the United States engaged heavily in it, tripling the world wide dollar reserves by creating money both at home and abroad. Other Central Banks, such as those of Great Britain and the European Union, similarly engaged in the practice to help mitigate the effects of the crisis and resulting Great Recession. These countries and economic blocks had all already lowered their interest rates to zero or near zero amounts, and they found quantitative easing to be their best remaining option for restarting economic growth.