The article on ‘What is Quantitative Easing?’ published by The Economist on March 09, 2015 explains the shift in monetary tools used by central banks around the World from conventional rate cuts and increases to more modern tools such as Quantitative Easing (QE). The article explains the process and working of QE and examines its utilities as a long term option for central bankers.
The article starts off with explaining that before the 2008-09 financial crisis, central banks could just alter interest rate to modify demand and supply of money in the economy. This rate adjustment factored in growth projections, economic activity levels and inflation among some other macroeconomic variables (R.A., 2015).
However, during and after the crisis, rate cuts to even near zero rates failed to stimulate the growth in economy and that prompted central banks to resort to QE. The mechanism through which QE works is that central banks buy bonds from banks, which gives the banks fresh capital to work with. These bonds were initially private securities, but now even government and other public debt is bought (R.A., 2015).
The fresh capital with banks would enable them to replace their old assets, which would raise stock prices and lower interest rates. This in turn is expected to boost investment activity resulting in higher growth.
As a result of such easing though, the balance sheet size of central banks has increased many folds. It is feared that once the central banks start offloading such assets back into the market, interest rates will shoot and would nullify the recovery (R.A., 2015).
We have seen over the last three years that even the idea of US Fed tapering the QE program has resulted in huge spike in interest rates across the globe and triggered panic. Thus QE should be utilised in a cautious and well coordinated manner along with other central banks (Kenny, 2014).
Reference List
R.A., 2015. What is quantitative easing? The Economist, [online] Mar 09, 2015. Available at <http://www.economist.com/blogs/economist-explains/2015/03/economist-explains-5>.
Kenny, T., 2014. An Explanation of Fed Tapering and its Impact on the Markets. About.com, [online] Dec 16, 2014. Available at <http://bonds.about.com/od/Issues-in-the-News/a/An-Explanation-Of-Fed-Tapering-And-Its-Impact-On-The-Markets.htm>.
