What is Quantitative Easing (QE)?
Quantitative Easing (QE) refers to a form of monetary policy where the central bank attempts to encourage economic growth by purchasing long-term securities to increase the money supply.
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What is the Definition of Quantitative Easing in Economics?
With quantitative easing (QE), a central bank aims to stimulate the economy with bond purchases, since increasing the money in circulation reduces interest rates.
The theory behind quantitative easing (QE) states that “large-scale asset purchases” can flood the economy with money and reduce interest rates – which in turn encourages banks to lend and makes consumers and businesses spend more.
If a country’s central bank is actively engaged in QE policies, it will purchase financial assets from commercial banks to increase the amount of money in circulation.
The types of financial assets purchased are most often the following:
- Government Bonds
- Corporate Bonds
- Mortgage-Backed Securities (MBS)
How Does Quantitative Easing Work
The process of quantitative easing is explained below:
- Step 1. Quantitative easing occurs when the central bank buys a significant amount of securities in an effort to decrease interest rates.
- Step 2. The purchase of bonds contributes to more demand, resulting in higher bond prices.
- Step 3. Interest rates and bond prices have an inverse relationship, so interest rates decline from rising bond prices.
- Step 4. The low-interest rate environment encourages more lending to consumers and corporate borrowers – plus, more capital flows into equities rather than cash and fixed-income securities with low yields.
Usually, in a country that is experiencing short-term interest rates near or at zero, consumers are saving rather than spending / investing, so the level of economic activity is low.
If interest rates become negative, however, the incentive to save money is reduced as its value is eroded by inflation.