Quantitative easing is a monetary policy that is occasionally used by the central bank to lower interest rates and increase money supply. The policy is often used to enhance growth of the economy. Quantitative easing increases money supply by ensuring that financial institutions have enough cash within their disposal. As a result, consumers will be encouraged to borrow money.
Quantitative easing leads to increased liquidity and lending. The policy is therefore considered when there is no printing of new banknotes and when short term interest rates are approaching zero.
To ensure successful implementation of the policy, the Central bank buys government bonds. This is a step that lowers short term interest rates and increases the amount of money in circulation. Therefore, when the strategy loses its effectiveness in commercial banks, financial institutions will be forced to explore other strategies to boost economic growth.
Additionally, the Central bank through quantitative easing, targets private financial institutions and commercial banks to spur economic growth. Central bank achieves this by encouraging banks to give out loans. However, if there is a lot of money in circulation, the same policy is used by the bank to increase interest rates of inflation. This is based on the fact that there is a fixed amount of money in circulation.
In addition, financial institutions may decide to keep cash accumulated through quantitative easing in their reserves other than lending out, as a step to enhance economic growth.
The Central bank can purchase government bonds from different institutions including
- Insurance companies
- Pension funds
- High Street banks
- Private sector financial institutions and many others
When there is an increased demand for government bonds, their value also increases. This makes them even more expensive to purchase even within a short span of time. As a result, they become less attractive in terms of investment. As a result, companies selling these bonds will invest in consumers other than in buying bonds. This step is aimed at lowering interest rates, increasing the amount of money in circulation and enhancing economic growth.
Quantitative easing has been proven very effective in enhancing economic growth especially in the UK. It is a policy that has been used in the UK over many years to prevent credit-led-depression. Without the policy, many economies across the globe would have probably been crippled.
The Central bank can also use quantitative easing policy to prevent deflation. If the bank wants to achieve this goal, it ensures that enough money is printed solely for the purpose of preventing deflation. It is good to note that in this case, the government of the central bank will not print new bank notes to prevent a deficit or to finance a deficit.
In many countries, the policy is used occasionally. Once the government has achieved its goal of stabilizing the economy, it stops to buy bonds and starts to sell them back to the market. The government will however ensure that the economy has fully recovered and there are no chances of a deficit before it starts to sell back its bonds.
The Central bank can buy bonds specifically from financial institutions as opposed to buying them from the government.
When struggling with your essays, Premium Essays is the place to seek help. We have an experienced team of writers and editors work on quality essays. We handle all topics within any given deadline. Place your order for any academic paper and we will deliver the best.