Quantitative Easing Explained: Main Talking Points

  • What is Quantitative Easing?

    Quantitative easing (QE) is a monetary policy tool utilized by central banks to stimulate the domestic economy when traditional methods prove ineffective. With interest rates near zero, the Federal Reserve, the Bank of Japan, the European Central Bank, and the Bank of England have all turned to quantitative easing as a means to influence their respective economies.

  • Diminishing Returns in Japan

    After years of implementing quantitative easing, the Bank of Japan has experienced diminishing economic and financial returns. Despite multiple rounds of stimulus and a negative interest rate environment, Japan continues to struggle with low economic growth and deflation.

  • Effectiveness of QE in Europe

    The European Central Bank has also utilized quantitative easing; however, the effectiveness of their long-term refinancing operations (LTROs) remains in question. While these measures were implemented to avoid sub-zero inflation and stabilize the Eurozone economy, inflation and growth in the region have remained subdued.

Federal Reserve Bank Total Assets

How Does Quantitative Easing Work?

Quantitative easing is a process through which central banks increase the money supply in the economy. This is achieved by purchasing securities, most commonly government bonds, from member banks. The increased supply of money reduces the cost of borrowing, making it cheaper for businesses to access funds for expansion purposes. In turn, this stimulates economic growth. QE differs from traditional interest rate cuts as it has the potential to lower the cost of longer-term loans, directly impacting lending for various sectors including housing and small businesses.

The Federal Reserve Bank (FED) Quantitative Easing Policy

As the central bank of the United States, the Federal Reserve plays a crucial role in maintaining a stable and secure monetary and financial system. The Fed’s responsibilities include managing inflation and promoting employment. In pursuing these objectives, the Fed has a range of monetary policy tools at its disposal. While adjusting the federal funds rate is a commonly known tool, the central bank’s balance sheet has gained significant importance and investor interest. The Fed’s balance sheet records the assets and liabilities across all the Federal Reserve bank branches and is utilized as a supplementary and unconventional monetary policy tool when traditional methods prove inadequate.

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Change in Fed Balance Sheet due to Quantitative Easing

Federal Reserve Bank Total Assets

The Federal Reserve’s balance sheet, similar to any other balance sheet, comprises distinct assets and liabilities. Since the 2008 financial crisis, the Fed has employed quantitative easing to effectively increase the supply of money in the US economy. This involved the purchase of significant amounts of treasury bills, notes, bonds, asset-backed securities, and mortgage-backed securities of high quality. These measures were accompanied by cuts to the Fed Funds rate, resulting in an interest rate range of 0 to 0.25%. By expanding its balance sheet and increasing liquidity, the Fed aimed to ease financial conditions and stimulate economic recovery.

Change in Fed Balance Sheet due to Quantitative Easing

The implementation of quantitative easing by the Federal Reserve was necessary due to the limited potential of further traditional policy efforts, such as interest rate cuts, in driving economic growth. As a result, the Fed pursued subsequent rounds of quantitative easing known as QE2 and QE3. These programs targeted the purchase of similar assets in order to support growth and stabilize capital markets in the United States. While quantitative easing has had its positive impacts, it remains a subject of debate. In recent years, there has been a discussion surrounding the reduction of the Fed’s balance sheet, known as Quantitative Tightening, as the US economy has seen over a decade of expansion, albeit with uneven growth and external risks like trade wars.

Bank of Japan balance sheet

The Bank of Japan (BOJ) Quantitative Easing Policy

The Bank of Japan has employed quantitative easing as a policy tool in attempting to combat low growth and deflation. However, its effectiveness has been limited. Early attempts in the late 1990s to purchase commercial paper and long-term government bonds had mixed results, and growth remained subdued. In the years since the financial crisis, the BOJ has conducted multiple rounds of QE and qualitative monetary easing (QQE), but these measures have had limited impact. The BOJ’s extensive purchases of Japan’s exchange-traded fund (ETF) market and real estate investment trusts (J-REITs) have raised concerns about the bank’s exposure and risk, particularly in the event of an economic downturn.

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change in BoJ balance sheet due to quantitative easing

The Bank of England (BOE) Quantitative Easing Policy

The Bank of England has also employed quantitative easing to bolster the UK’s economy during periods of recession and political uncertainty, such as the global financial crisis, the Scottish Referendum vote, the General Election, and eventually the Brexit. The BOE’s holdings of local government bonds (GILTs) and corporate bonds have increased through QE. In comparison to other central banks, the BOE’s holdings are relatively smaller. As of early 2019, these holdings accounted for 5.7% of national GDP. The BOE’s approach to quantitative easing ensures a safety net for the economy while avoiding potential diminishing returns associated with larger balance sheets.

change in BoE balance sheet due to quantitative easingBank of England balance sheet

The European Central Bank (ECB) Quantitative Easing Policy

The European Central Bank pursued quantitative easing in response to the Eurozone Debt Crisis and deflation concerns within the region. The ECB’s asset purchase program, which included government bonds, corporate debt, asset-backed securities, and covered bonds, aimed to stimulate economic growth and prevent sub-zero inflation. The program, which lasted from March 2015 to December 2018, involved significant purchases at a rate of 1.3 million Euros per minute, equating to 7,600 Euros per person in the Eurozone. The effectiveness of these measures has been limited, necessitating additional measures such as targeted long-term refinancing operations (TLTROs) to stabilize bank balance sheets and lower sovereign debt yields.

ECB Balance Sheet

Negative Effects of QE: Balance Sheet Use and Diminishing Returns

While quantitative easing has shown positive results for the Federal Reserve, it has had less success in Japan and Europe, and has even contributed to negative consequences. In Japan, years of expansionary policies have resulted in deflation, and the BOJ’s balance sheet now exceeds the country’s GDP. Risk is heightened due to its large ownership of ETFs, J-REITs, and government bonds. Similarly, the ECB has seen diminishing returns from their quantitative easing programs as inflation and growth remain stagnant within the Eurozone.

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ECB Monetary Policy

The Impact of Quantitative Easing on Currencies

Quantitative easing, by increasing the money supply, can potentially lead to a decrease in the value of a currency. However, currency values are relative, as they are traded in pairs. The implementation of quantitative easing by multiple central banks has resulted in a prevailing trend of dovish monetary policies and increased money supply. As a result, global currencies have experienced fluctuations in value. The comparative dovishness of central banks has led to subtle competitive policies, sometimes referred to as a “currency war”. Ultimately, the impact of quantitative easing on currencies depends on the relative policies and actions of different central banks.

Conclusion

Quantitative easing has become a widely-used monetary policy tool among central banks worldwide, but its long-term effectiveness remains uncertain. While QE has shown positive results in the US, it has had mixed outcomes in Japan and Europe. The impact on currencies can vary depending on the relative policies of central banks. As central banks continue to navigate the challenges of sustaining economic growth and managing external risks, the role and future of quantitative easing as a permanent monetary policy tool remain to be seen.

global money supply

Note: The content of this article is for informational purposes only and should not be considered as financial or investment advice.