Quantitative easing

Definition

Quantitative easing is a monetary policy strategy used by central banks to stimulate the economy by increasing the money supply through the purchase of financial assets, such as government bonds. This approach aims to lower interest rates, boost lending and investment, and support economic growth, particularly during periods of economic downturn or recession. The impact of quantitative easing can influence exchange rates and currency markets as it alters the dynamics of money supply and interest rates within a country.

5 Must Know Facts For Your Next Test

1. Quantitative easing was notably implemented after the 2008 financial crisis as central banks sought to prevent economic collapse and promote recovery.
2. By increasing the money supply, quantitative easing can lead to depreciation of the national currency, making exports cheaper and imports more expensive.
3. This policy can lead to asset bubbles if investors seek higher returns in riskier assets due to low yields on safer investments.
4. Critics argue that prolonged use of quantitative easing can create distortions in financial markets and contribute to income inequality.
5. Quantitative easing is generally seen as a temporary measure, with central banks eventually needing to reverse or taper these policies as the economy improves.

Review Questions

• How does quantitative easing affect exchange rates and what implications does this have for international trade?
  • Quantitative easing typically leads to a decrease in interest rates and an increase in money supply, which can cause a depreciation of the national currency. This depreciation makes exports more competitive in international markets while making imports more expensive. As a result, countries that employ quantitative easing may see an increase in export-driven economic growth but could also face higher costs for imported goods, impacting inflation rates.
• Evaluate the effectiveness of quantitative easing as a response to economic downturns compared to traditional monetary policy tools.
  • Quantitative easing has proven effective in providing liquidity and stabilizing financial markets during severe economic downturns, especially when traditional monetary policy tools like lowering interest rates are no longer viable. It allows central banks to directly influence asset prices and encourage lending. However, its effectiveness may diminish over time if it leads to adverse side effects, such as asset bubbles or rising inequality, prompting ongoing debates about its long-term viability compared to conventional approaches.
• Analyze the broader implications of prolonged quantitative easing on global financial stability and economic inequality.
  • Prolonged quantitative easing can create significant global financial stability risks by encouraging excessive risk-taking among investors in search of higher returns due to artificially low interest rates. This can lead to inflated asset prices and potential market corrections. Additionally, the policy often disproportionately benefits wealthier individuals who are more likely to own financial assets, exacerbating economic inequality. As a result, while quantitative easing aims to stimulate growth, it can simultaneously deepen socio-economic divides and generate volatility in global markets.

Related terms

Monetary Policy: The process by which a central bank manages the money supply and interest rates to achieve specific economic goals.

Interest Rates: The cost of borrowing money, usually expressed as a percentage of the amount borrowed, which is influenced by central bank policies.

Asset Purchase Program: A specific initiative by a central bank to buy financial assets with the goal of injecting liquidity into the economy.