Regarding the concept of quantitative easing (QE), there may be many different and controversial definitions in the industry. But basically, this is a market operation mechanism (executed by the central bank) that increases liquidity and inflation. Its purpose is to stimulate a country's economy, encourage businesses and consumers to increase borrowing and consumption behavior, and stimulate domestic demand.
How does it work?
Typically, this operation involves the central bank injecting financial flows into the economic system by purchasing securities (such as stocks, bonds, and treasury assets, etc.) from the government or commercial banks.
The central bank increases the reserve funds of member banks (based on the portion of reserves held by the banking system) by expanding the scale of new credit activities. Since the new credit practices are not backed by any entity of commodity or material value, it can be said that quantitative easing (QE) basically comes out of nowhere.
The purpose of quantitative easing (QE), therefore, is to increase the money supply and make money more readily available as a way to stimulate economic activity and growth. The general idea is to keep interest rates low, promote lending by businesses and consumers, and boost confidence in the overall economy. In practice, however, quantitative easing does not always work, and is, in fact, a very controversial approach for both proponents and opponents.
Quantitative easing is a relatively loose monetary policy. Some scholars believe that the Bank of Japan first used this policy in the late 1990s (which it arguably did). This is controversial, as many economists debate whether Japan's monetary practices at the time actually constituted quantitative easing (QE). Since then, several other countries have also begun to implement quantitative easing policies to minimize economic crises.
What spurred the use of quantitative easing (QE)?
Quantitative easing is designed to address economic downturns that traditional banking has failed to protect against. The main goal of quantitative easing is to increase inflation (to avoid deflation) - interest rate adjustments are one of the main tools central banks use to control inflation rates. When lending and financial activity slows, a country's central bank can lower interest rates to enable banks to effectively address lending pressures. In contrast, when policy is too casual, that is, when spending and credit approach risky levels, higher interest rates may become a trigger to stop.
Is quantitative easing effective?
Shortly after the 2008 financial crisis, the International Monetary Fund (IMF) issued a note in which QE was viewed as an effective unconventional monetary policy. The analysis includes the five major central banks: the Federal Reserve, the European Central Bank, the Bank of England, the Bank of Canada and the Bank of Japan.
Each institution employs a unique strategy, and most significantly increase overall market liquidity. The report said central bank interventions were successful and the increase in liquidity played a crucial role in averting a protracted economic crisis and a collapse of the financial system.
However, QE is not always effective and is highly dependent on economic context and strategy. Many economies that have experimented with quantitative easing (or similar methods) have not had the desired results. Injecting money into the economy and lowering interest rates can lead to surprises and adverse effects if not managed properly. Below we list some potential advantages and disadvantages.
Potential advantages and positive impacts
Providing more credit funds: Due to the increase in funds through central bank asset purchases, banks are encouraged to provide more loans.
Increased borrowing: When interest rates are low, consumers and businesses are more likely to take on new borrowing.
Increased spending: As new loans and borrowings generate more money, consumers will increase spending. Because when interest rates are low, it's not attractive to keep money in hand.
Increased employment: When businesses receive more capital through loans and become more profitable due to increased consumer spending, they are encouraged to expand operations and hire more workers.
Potential Disadvantages and Negative Effects
Many experts have expressed concerns that QE is just a Band-Aid on larger structural problems that could fuel the economy. Some potential disadvantages include:
Inflation: The increase in money supply brought about by quantitative easing naturally leads to inflation. Product competition will increase because more money is circulating, but there is no increase in the supply of goods. Increased demand leads to higher prices. If not managed properly, inflation rates can rise rapidly, leading to hyperinflation.
No forced lending: In quantitative easing, commercial banks intend to use the funds they receive from the central bank to provide more loans. But nothing in the process requires them to do so. For example, when quantitative easing was initially implemented in the United States after the 2008 financial crisis, many banks chose to hold the new money rather than spread it.
More debt: Increased borrowing could cause businesses and consumers to borrow more than they can afford, which could have a negative impact on the economy.
Impact on other investment instruments: Bond markets often react negatively to instability and sudden changes, which became very common after the implementation of quantitative easing policies.
Case
Some central banks that have used quantitative easing include:
Bank of Japan: 2001-2006 and 2012 (Abenomics).
Quantitative easing efforts have done little to alleviate their financial problems. The yen weakened against the dollar and import costs rose.U.S. Central Bank: 2008-2014.
The U.S. central bank implemented three rounds of quantitative easing to address the subprime crisis and subsequent economic recession. Economic recovery, but whether due to quantitative easing is controversial. Comparisons with Canada, which did not use QE, show no significant differences.European Central Bank: 2015-2018.
The eurozone has suffered setbacks and failures, with persistent inflation and falling unemployment, and while it recovered strongly in 2017, it is still dealing with sluggish economic growth and rising interest rates.
Summary of opinions
As an unconventional monetary strategy, quantitative easing may have helped some economies recover, but it remains a highly controversial strategy and even that conclusion is questionable. While most potential risks, such as hyperinflation and over-borrowing, have not yet had any damaging effects on economies, some countries using QE have also experienced currency instability and adverse effects on other economic sectors and markets. The long-term impact of using quantitative easing policy is not yet clear enough, and the impact of quantitative easing on the economy may lead to completely different results depending on different circumstances.