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What is quantitative easing?

2015-12-04 13:13:19

3 December 2015

The European Central Bank has outlined further action aimed at stimulating the

eurozone economy.

One way it is trying to do so is by boosting the amount of overall money in the

banking system through something known as quantitative easing, or QE.

While the United States has wound down its programme of QE now that the economy

is growing more steadily, the eurozone only began its version in January 2015,

pledging to put an extra 60bn ($63bn) into the system each month.

What is QE?

Governments and central banks like there to be "just enough" growth in an

economy - not too much that could lead to inflation getting out of control, but

not so little that there is stagnation. Their aim is the so-called "Goldilocks

economy" - not too hot, but not too cold.

One of the main tools they have to control growth is raising or lowering

interest rates. Lower interest rates encourage people or companies to spend

money, rather than save.

But when interest rates are almost at zero, central banks need to adopt

different tactics - such as pumping money directly into the financial system.

This process is known as quantitative easing or QE.

How does it work?

The central bank buys assets, usually government bonds, with money it has

"printed" - or, more accurately, created electronically.

It then uses this money to buy bonds from investors such as banks or pension

funds. This increases the overall amount of funds in the financial system.

Making more money available is supposed to encourage financial institutions to

lend more to businesses and individuals. It can also push interest rates lower

across the economy, even when the central bank's own rates are just about as

low as they can go. This in turn should allow businesses to invest and

consumers to spend more, giving a knock-on boost to the economy.

What are the risks?

The biggest concern is that pumping more money into the economy could

ultimately lead to an inflation problem, though at present, the issue is that

eurozone inflation is too low.

When inflation is close to zero, a bit more upward pressure on prices can be

seen as a good thing. But some politicians and economists have opposed the idea

of QE in principle, because they believe in the long run, there's a danger that

it could create too much inflation.

Others argue that the extra money has just bolstered the price of some assets

such as shares and property in some countries.

Who else has tried QE?

Both the Bank of England and the US Federal Reserve embarked on QE in the wake

of the 2008 financial crisis in an attempt to stimulate economic growth.

Between 2008 and 2015, the US Federal Reserve in total bought bonds worth more

than $3.7 trillion.

The UK created 375bn ($550bn) of new money in its QE programme between 2009

and 2012.

The eurozone began its programme of QE in January 2015 and has so far pumped in

$600bn of extra money. Originally the programme was set to run until September

2016, but it has now been extended until at least March 2017.

QE was first attempted by Japan's central bank to arrest a period of deflation

following its financial turmoil in the 1990s. There is disagreement about

whether the initiative had the intended effect of stimulating the Japanese

economy.

Has QE worked?

Over the last few years, the US economy has stabilised and unemployment has

fallen steadily. Some credit QE for the recovery, at least in part.

European Central Bank governor Mario Draghi said in June 2015 that the policy

had "contributed to a broad-based easing in financial conditions, a recovery in

inflation expectations and more favourable borrowing conditions for firms and

households".

Are there any losers from QE?

QE pushes up the market price of government bonds and reduces the yield paid

out to investors. In other words, investors have to pay more to get the same

income.

The US's programme of QE also kept the value of the dollar lower than it might

otherwise have been, a factor not welcomed in some emerging economies. Since

the end of QE in the US and with the prospect of interest rate rises there, the

dollar has regained strength. The ECB's QE has led to a weakening of the euro.