Welcome to our explanation of Quantitative Easing, often abbreviated as QE. Quantitative Easing is a monetary policy tool used by central banks when traditional interest rate policies are no longer effective. Its primary purpose is to stimulate economic growth when interest rates are already near zero. In this situation, central banks need alternative methods to inject money into the economy and encourage spending and investment.
Now, let's explore how Quantitative Easing actually works. The process begins when a central bank creates new money electronically. Unlike printing physical currency, this is done with a few keystrokes in the central bank's computer system. The central bank then uses this newly created money to purchase government bonds and sometimes other securities like mortgage-backed securities from financial markets. This increases the reserves of commercial banks and injects liquidity into the financial system. As a result, long-term interest rates are pushed down, which encourages banks to lend more money and businesses and consumers to borrow, invest, and spend.
Let's examine the economic effects of Quantitative Easing. The intended effects include increasing the money supply, lowering long-term interest rates, boosting asset prices, encouraging lending and investment, and ultimately promoting economic growth and job creation. As shown in our graph, after QE implementation, we typically see economic growth trending upward while interest rates decline. However, QE is not without risks. These include the potential formation of asset bubbles as excess liquidity flows into financial markets, the possibility of inflation if too much money chases too few goods, and currency devaluation which can affect international trade. These risks tend to increase the longer QE policies remain in place, as indicated by our risk zone on the graph.
Let's look at some historical examples of Quantitative Easing. The Federal Reserve in the United States implemented QE in response to the 2008 financial crisis, continuing various phases until 2014, and then again in 2020 during the COVID-19 pandemic. In total, the Fed's asset purchases exceeded 8 trillion dollars. The European Central Bank began its QE program later, running from 2015 to 2018 with approximately 2.6 trillion euros in purchases, followed by additional rounds from 2019 to 2022. The ECB also combined QE with negative interest rates. The Bank of Japan has the longest-running QE program, beginning in 2001 and continuing to this day. Japan's program is particularly notable as the central bank's assets now exceed 100% of Japan's GDP, and their purchases include not just government bonds but also exchange-traded funds and real estate investment trusts. As you can see on our timeline, QE has become a standard tool for central banks during economic crises, with the 2008 financial crisis and the 2020 pandemic triggering major implementations.
To summarize what we've learned about Quantitative Easing: QE is a monetary policy tool used by central banks when interest rates are near zero and traditional policies are no longer effective. The process involves central banks creating new money electronically to purchase long-term securities, which increases liquidity in the financial system and lowers long-term interest rates. The primary goals of QE are to stimulate economic growth, encourage lending and investment, and create jobs. We've seen major implementations of QE in response to the 2008 financial crisis and the 2020 COVID-19 pandemic by central banks around the world. However, QE is not without risks, including the potential formation of asset bubbles, inflation if too much money enters the system, and currency devaluation. Understanding QE is crucial for comprehending modern monetary policy and how central banks respond to economic crises.