Quantitative Easing (QE): What It Is and How It Works

What Is Quantitative Easing?

Quantitative easing (QE) is a form of monetary policy in which a central bank, like the U.S. Federal Reserve, purchases securities in the open market to reduce interest rates and increase the money supply.

Quantitative easing creates new bank reserves, providing banks with more liquidity and encouraging lending and investment. In the United States, the Federal Reserve implements QE policies.

Understanding Quantitative Easing

Quantitative easing is often implemented when interest rates hover near zero and economic growth is stalled. Central banks have limited tools, like interest rate reduction, to influence economic growth. Without the ability to lower rates further, central banks must strategically increase the supply of money.

To execute quantitative easing, central banks buy government bonds and other securities, injecting bank reserves into the economy. Increasing the supply of money provides liquidity to the banking system and lowers interest rates further. This allows banks to lend with easier terms.

A government’s fiscal policy may be implemented concurrently to expand the money supply. While the Federal Reserve can influence the supply of money in the economy, the U.S. Treasury Department can create new money and implement new tax policies with fiscal policy. This sends money, directly or indirectly, into the economy.

Quantitative easing can involve a combination of both monetary and fiscal policies.

Does Quantitative Easing Work?

Most economists believe that the Federal Reserve’s quantitative easing program helped to rescue the U.S. and the global economy following the 2007–2008 financial crisis; however, the results of QE are difficult to quantify.

Globally, central banks have attempted to deploy quantitative easing as a means of preventing recession and deflation in their countries with similarly inconclusive results. While QE policy is effective at lowering interest rates and boosting the stock market, its broader impact on the economy isn’t apparent.

Commonly, the effects of quantitative easing benefit borrowers over savers and investors over non-investors, so there are pros and cons to QE, according to Stephen Williamson, a former economist with the Federal Reserve Bank of St. Louis.

Risks of Quantitative Easing

Inflation

As money is added to an economy, the risk of inflation looms. While the liquidity works its way through the system, central banks remain vigilant, as the time lag between the increase in the money supply and the inflation rate is generally 12 to 18 months.

A quantitative easing strategy that does not spur intended economic growth but causes inflation can also create stagflation, a scenario where both the inflation rate and the unemployment rate are high.

Limited Lending

Even though liquidity increases for banks, a central bank like the Fed cannot force banks to increase lending activities, nor can it force individuals and businesses to borrow and invest. This creates a credit crunch, where cash is held at banks or corporations hoard cash due to an uncertain business climate.

Devalued Currency

Quantitative easing may devalue the domestic currency as the money supply increases. While a devalued currency can help domestic manufacturers because the goods they export become cheaper in the global market, a falling currency value makes imports more expensive, increasing the cost of production and consumer price levels.

Real-World Examples of Quantitative Easing

United States

To combat the Great Recession, the U.S. Federal Reserve ran a quantitative easing program from 2009 to 2014. The Federal Reserve’s balance sheet increased with bonds, mortgages, and other assets. By 2017, U.S. bank reserves had grown to over $4 trillion, providing the liquidity to lend those reserves and stimulate overall economic growth. However, banks held on to $2.8 trillion in excess reserves, an unexpected outcome of the Federal Reserve’s QE program.

In 2020, the Fed announced its plan to purchase $700 billion in assets as an emergency QE measure following the economic and market turmoil spurred by the COVID-19 shutdown. However, in 2022, the Federal Reserve dramatically shifted its monetary policy to include significant interest rate hikes and a reduction in the Fed’s asset holdings meant to sidetrack the persistent trend of higher inflation that emerged in 2021.

Europe and Asia

Following the Asian Financial Crisis of 1997, Japan fell into an economic recession. The Bank of Japan began an aggressive quantitative easing program to curb deflation and stimulate the economy, moving from buying Japanese government bonds to buying private debt and stocks. The quantitative easing campaign’s effect was only temporary, as the Japanese gross domestic product (GDP) rose from $4.1 trillion in 1998 to $6.27 trillion in 2012 but receded to $4.44 trillion by 2015.

The Swiss National Bank (SNB) also employed a quantitative easing strategy following the 2008 financial crisis, and the SNB came to own assets that exceeded the annual economic output for the entire country. Although economic growth was spurred, it is unclear how much of the subsequent recovery can be attributed to the SNB’s quantitative easing program.

In August 2016, the Bank of England (BoE) launched a quantitative easing program to help address the potential economic ramifications of Brexit. By buying £60 billion of government bonds and £10 billion in corporate debt, the plan was intended to keep interest rates from rising and stimulate business investment and employment.

By June 2018, the Office for National Statistics in the United Kingdom reported that gross fixed capital formation was growing at a compound average quarterly rate of 0.2% over the prior 10 years, but at 0.8% excluding the economic downturn, compared with 0.6% for the decade preceding the downturn.

U.K. economists were unable to determine whether or not growth would have been evident without this quantitative easing program.

The Bottom Line

Quantitative easing is a form of monetary policy in which a central bank, like the U.S. Federal Reserve, purchases securities through open market operations to increase the supply of money and encourage bank lending and investment. QE policies have been implemented globally. However, their impact on a country’s economy is often debated.