What is quantitative easing?


What is quantitative easing?

In: Economics

Quantitative easing is a tactic used by a country’s central bank (eg. The federal reserve) to add money to the country’s economy, primarily in times when the economy is slow or have collapsed. Because the central bank cannot give away money for free, it makes large purchases of government bonds or financial assets(Billions of dollars worth of assets). Once the bonds are purchased, the money is then used to fulfill the purpose of the bond (build roads, develop systems etc). This now means that people will be hired to build the roads, materials will be bought and so forth, so that money will now be circulated in the economy thanks to quantitative easing.

Ignore all the words in “Quantitative Easing”, they don’t mean anything. It’s the central bank giving out large loans to other banks. The central bank prints money. In a fiat currency like ours, they have an infinite supply. They buy bonds in bulk. IE, money from nowhere goes into the banks and now they have more money to loan out themselves. Bonds have interest rates and such, so it’s not money-for-nothing. But in financial terms it’s about as close as you can get.

This would be disastrous if inflation is a worry, but if the economy is sluggish and inflation is alright, they can give money to the banks to try and liven things up. It DOES solve any worry about deflation.

You know how you work hard for your money? Well if the banks aren’t doing so hot, they’ll just give banks more cash to play with.

I’ve always wondered instead of buying bonds from banks can the money be injected from bottom up by giving say $500 to every American?

These measures are often described as necessary to preserving liquidity. How does that work? What locks up if the Fed doesn’t do this? What necessary transaction does someone refuse to engage in? In 2008, I heard about credit card transaction approvals being frozen. What’s the mechanism that caused (now would cause?) that?

Imagine if a pawn shop was being run by a magician.

Say that you just got fired from your job. On paper you might have a reasonable net worth: you own a showmobile, a jet ski, some art, etc. but you were living paycheck to paycheck and don’t have much liquid cash. Your immediate plan is probably to spend less while looking for a new job – right? Well lets say that there is someone out there who doesn’t want you to do that. They want you to keep spending. How could they help you out with that?

They let you pawn your stuff to them. You give them your jet ski, your snowmobile, your art, and they give you cash. You can now spend and in a few months when you find a new job you can pay them back and get your stuff back.

The only twist to this with QE is that the pawn broker, the FED, owns the money printing presses and is just creating money out of thin air. But at the same time the asset that is being pawned to them is an IOU that THEY ISSUED. So people are mostly willing to say “well actually they are not really creating money…. not in a way that matters to inflation”. Everyone kind of holds their noses at this weird situation because they figure in six months the banks will get their bonds out of the pawn shop, and the money that was printed will be destroyed, and everything will go back to how it was before, EXCEPT that the economy will be helped. So its like a magic trick. Something winks into existence just long enough for the audience to see it and then poof its gone again like it never happened.

Pro tip: do not ask monetary policy questions on ELI5. Most people who comment here are non-specialists, this is an extremely complex topic that is hard to break down in a way that’s easy to understand, and most of the attempts that are made are quite poor / misguided.

You’d be better off reading a very basic introductory college textbook on the topic that skips over the mathematical treatment of it. I recommend Greg Mankiw’s macro textbook, it’s pricey but I am positive you can snoop around the web for a free pdf

It’s when the central bank greatly increases the number of assets it buys off the market in order to inject liquidity into the economy. It works by the central banking buying up billions or trillions of bonds and mortgage backed securities. The investor or bank has sold the bond on the market like they would any other time, and the central bank now owns it. As the bond is paid off, the bank effectively destroys that money.

It is not a bailout. It is not a loan. The central bank creates the money it uses to buy the. It’s not as inflationary as you may hear because almost just as much money is destroyed once the bonds mature. The purpose is to increase the amount of available cash that investors and banks can then, hopefully, reinvest in the economy. By not doing this, a downturn may become a recession as people and businesses struggle to get loans to restart the economy.