Quantitative easing

Overview

Quantitative easing (QE) is a monetary policy action where a central bank purchases predetermined amounts of government bonds, company shares, or other financial assets (liquidity) in order to artificially stimulate economic activity. Quantitative easing is a novel form of monetary policy that began in Japan and came into wide application in the US following the 2008 financial crisis. It attempts to mitigate economic recessions when inflation is very low or negative. Quantitative tightening does the opposite, where for monetary policy reasons, a central bank sells off some portion of its holdings of government bonds or other financial assets. Similar to conventional open-market operations used to implement monetary policy, a central bank implements quantitative easing by buying financial assets from commercial banks and other financial institutions, thus raising the prices of those financial assets and lowering their yield, while simultaneously increasing the money supply. However, in contrast to conventional monetary policy, quantitative easing usually involves the purchase of riskier or longer-term assets (rather than short-term government bonds) of predetermined amounts at a large scale, over a pre-determined period of time. Central banks usually resort to quantitative easing when interest rates approach zero, such as in 2008 and 2020 for the US and in 1999 for Japan. Very low interest rates induce a liquidity trap, a situation where people prefer to hold cash or very liquid assets, given the low returns on other financial assets. This makes it difficult for interest rates to go below zero; monetary authorities may then use quantitative easing to stimulate the economy rather than trying to lower the interest rate. Quantitative easing can help bring the economy out of a recession and help ensure that inflation does not fall below the central bank's inflation target. The term quantitative easing was coined by economist Richard Werner in 1995. Since then, it has faced a range of criticisms. Economists argue that it can inflate asset bubbles, potentially worsening a recession rather than alleviating it. Others highlight QE's mixed side effects and risks: it may overshoot its goal by countering deflation too aggressively and fueling long-term inflation, or fail to stimulate growth if banks remain reluctant to lend and borrowers hesitant to borrow. QE has also been criticized for raising financial asset prices, and thereby contributing to economic inequality. Major central banks around the world, including the US, UK, EU, and Japan, have implemented quantitative easing following the 2008 global financial crisis and again in response to the COVID-19 pandemic.

Process and benefits

Standard central bank monetary policies are usually enacted by buying or selling government bonds on the open market to reach a desired target for the interbank interest rate. However, if a recession or depression continues even when a central bank has lowered interest rates targets to nearly zero, the central bank can no longer lower interest rates — a situation known as the liquidity trap. The central bank may then attempt to stimulate the economy by implementing quantitative easing, that is, by buying financial assets without reference to interest rates. This policy is sometimes described as a last resort to stimulate the economy. A central bank enacts quantitative easing by purchasing, regardless of interest rates, a predetermined quantity of bonds or other financial assets on financial markets from private financial institutions. This action increases the excess reserves that banks hold. The goal of this policy is to ease financial conditions, increase market liquidity, and encourage private bank lending. Quantitative easing affects the economy through several channels:

Credit channel By providing liquidity in the banking sector, QE makes it easier and cheaper for banks to extend loans to companies and households, thus stimulating credit growth. Additionally, if the central bank also purchases financial instruments that are riskier than government bonds (such as corporate bonds), it can also increase the price and lower the interest yield of these riskier assets. Portfolio rebalancing By enacting QE, the central bank withdraws an important part of the safe assets from the market onto its own balance sheet, which may result in private investors turning to other financial securities. Because of the relative lack of government bonds, investors are forced to "rebalance their portfolios" into other assets. Additionally, if the central bank also purchases financial instruments that are riskier than government bonds, it can also lower the interest yield of those assets (as those assets are more scarce in the market, and thus their prices go up correspondingly). Exchange rate Because it increases the money supply and lowers the yield of financial assets, QE tends to depreciate a country's exchange rates relative to other currencies, through the interest rate mechanism. Lower interest rates lead to a capital outflow from a country, thereby reducing foreign demand for a country's money, leading to a weaker currency. This increases demand for exports, and directly benefits exporters and export industries in the country. Fiscal effect By lowering yields on sovereign bonds, QE makes it cheaper for governments to borrow on financial markets, which may empower the government to provide fiscal stimulus to the economy. Quantitative easing can be viewed as a debt refinancing operation of the "consolidated government" (the government including the central bank), whereby the consolidated government, via the central bank, retires government debt securities and refinances them into central bank reserves.:

Proposed fiscal-monetary extensions

Imputed Tax Quantitative Easing (ITQE) is a 2026 theoretical proposal that treats the fiscal and imputed-income effects of large-scale asset purchases as objects a central bank should internalize when it designs quantitative easing, rather than as incidental side effects. The framework maps standard QE transmission channels—portfolio rebalancing, signaling, preferred-habitat demand, fiscal space, risk-taking, and balance-sheet easing—onto System of National Accounts 2008 concepts of imputed income and imputed rental services, especially owner-occupied housing. The central bank is modeled as adding an imputed-tax adjustment term to its large-scale asset purchase rule. In the two-period household problem used in the monograph, lifetime utility is

U = u (

c

1

) + β u (

c

2

)

{\displaystyle U=u(c_{1})+\beta u(c_{2})}

subject to an intertemporal budget constraint that includes both explicit taxes and the imputed fiscal effects of long-bond purchases:

c

1

+

c

2

1 + r

=

y

1

−

History

The Bank of Japan introduced QE from March 19, 2001, until March 2006, after having introduced negative interest rates in 1999. Most western central banks adopted similar policies in the aftermath of the 2008 financial crisis.

Precedents

The methods behind QE had been implemented long before its creation. The US Federal Reserve belatedly implemented policies similar to the recent quantitative easing during the Great Depression of the 1930s. Specifically, banks' excess reserves exceeded 6 percent in 1940, whereas they vanished during the entire postwar period until 2008. Despite this fact, many commentators called the scope of the Federal Reserve quantitative easing program after the 2008 crisis "unprecedented".

Japan (2001–2006)

A policy termed "quantitative easing" (量的緩和, ryōteki kanwa, from 量的 "quantitative" + 緩和 "easing") was first used by the Bank of Japan (BoJ) to fight domestic deflation in the early 2000s. The BOJ had maintained short-term interest rates at close to zero since 1999. The Bank of Japan had for many years, and as late as February 2001, stated that "quantitative easing ... is not effective" and rejected its use for monetary policy. The Bank of Japan adopted quantitative easing on 19 March 2001. Under quantitative easing, the BOJ flooded commercial banks with excess liquidity to promote private lending, leaving them with large stocks of excess reserves and therefore little risk of a liquidity shortage. The BOJ accomplished this by buying more government bonds than would be required to set the interest rate to zero. It later also bought asset-backed securities and equities and extended the terms of its commercial paper-purchasing operation. The BOJ increased commercial bank current account balances from ¥5 trillion to ¥35 trillion (approximately US$300 billion) over a four-year period starting in March 2001. The BOJ also tripled the quantity of long-term Japan government bonds it could purchase on a monthly basis. However, the seven-fold increase notwithstanding, current account balances (essentially central bank reserves) being just one (usually relatively small) component of the liability side of a central bank's balance sheet (the main one being banknotes), the resulting peak increase in the BOJ's balance sheet was modest, compared to later actions by other central banks. The Bank of Japan phased out the QE policy in March 2006.

After 2007

Following the 2008 financial crisis, policies similar to those undertaken by Japan were used by the United States, the United Kingdom, and the Eurozone. Quantitative easing was used by these countries because their risk-free short-term nominal interest rates (termed the federal funds rate in the US, or the official bank rate in the UK) were either at or close to zero. According to Thomas Oatley, "QE has been the central pillar of post-crisis economic policy." During the peak of the 2008 financial crisis, the US Federal Reserve expanded its balance sheet dramatically by adding new assets and new liabilities without "sterilizing" these by corresponding subtractions. In the same period, the United Kingdom also used quantitative easing as an additional arm of its monetary policy to alleviate its financial crisis.

United States

One of the Federal Reserve System monetary policy tools is QE along with forward guidance when controlling short-term interest rates, the central bank's primary monetary policy tool, fails to achieve the desired effect. Although the Fed lacks statutory supervision and requires no outside approval to enact monetary policies, a 1977 amendment to the Federal Reserve Act gives the central bank a mandate to provide for moderate long-term interest rates, maximize employment, and stabilize prices, the latter two often referred to as the Fed's dual mandate. The two primary mechanisms of monetary policy by which the Fed can effectuate those economic conditions is to raise or lower interest rates or to increase or decrease the money supply. Within the Fed, the Federal Open Market Committee is responsible for deciding the Fed's monetary policy. The FOMC is composed of 12 members, including the president of the Federal Reserve Bank of New York, 4 presidents from a rotating selection of the 12 Federal Reserve Banks around the country, and 7 members of the system's Board of Governors. The Fed held between $700 billion and $800 billion of Treasury notes on its balance sheet before the recession. The US has used QE four times so far in its history, with varying degrees of intensity. November 2008: QE1. In late November 2008, the Federal Reserve started buying $600 billion in mortgage-backed securities. By March 2009, it held $1.75 trillion of bank debt, mortgage-backed securities, and Treasury notes; this amount reached a peak of $2.1 trillion in June 2010. Further purchases were halted as the economy started to improve, but resumed in August 2010 when the Fed decided the economy was not growing robustly. After the halt in June, holdings started falling naturally as debt matured and were projected to fall to $1.7 trillion by 2012. The Fed's revised goal became to keep holdings at $2.054 trillion. To maintain that level, the Fed bought $30 billion in two- to ten-year Treasury notes every month. November 2010: QE2. In November 2010, the Fed announced a second round of quantitative easing, buying $600 billion of Treasury securities by the end of the second quarter of 2011. The expression "QE2" became a ubiquitous nickname in 2010, used to refer to this second round of quantitative easing by US central banks. Retrospectively, the round of quantitative easing preceding QE2 was called "QE1". September 2012: QE3. A third round of quantitative easing, "QE3", was announced on 13 September 2012. In an 11–1 vote, the Federal Reserve decided to launch a new $40 billion per month, open-ended bond purchasing program of agency mortgage-backed securities. Additionally, the Federal Open Market Committee (FOMC) announced that it would likely maintain the federal funds rate near zero "at least through 2015". According to NASDAQ.com, this is effectively a stimulus program that allows the Federal Reserve to relieve $40 billion per month of commercial housing market debt risk. Because of its open-ended nature, QE3 has earned the popular nickname of "QE-Infinity". On 12 December 2012, the FOMC announced an increase in the amount of open-ended purchases from $40 billion to $85 billion per month. On 19 June 2013, Ben Bernanke announced a "tapering" of some of the Fed's QE policies contingent upon continued positive economic data. Specifically, he said that the Fed could scale back its bond purchases from $85 billion to $65 billion a month during the upcoming September 2013 policy meeting. He also suggested that the bond-buying program could wrap up by mid-2014. While Bernanke did not announce an interest rate hike, he suggested that if inflation followed a 2% target rate and unemployment decreased to 6.5%, the Fed would likely start raising rates. The stock markets dropped by approximately 4.3% over the three trading days following Bernanke's announcement, with the Dow Jones dropping 659 points between 19 and 24 June, closing at 14,660 at the end of the day on 24 June. On 18 September 2013, the Fed decided to hold off on scaling back its bond-buying program, and announced in December 2013 that it would begin to taper its purchases in January 2014. Purchases were halted on 29 October 2014 after accumulating $4.5 trillion in assets.

March 2020: QE4.

The Federal Reserve began conducting its fourth quantitative easing operation since the 2008 financial crisis; on 15 March 2020, it announced approximately $700 billion in new quantitative easing via asset purchases to support US liquidity in response to the COVID-19 pandemic. As of mid-summer 2022 this resulted in an additional $2 trillion in assets on the books of the Federal Reserve.

United Kingdom

The Bank of England's QE programme commenced in March 2009, when it purchased around £165 billion in assets as of September 2009 and around £175 billion in assets by the end of October 2009. Five further tranches of bond purchases between 2009 and November 2020 brought the peak QE total to £895 billion. The Bank imposed a number of constraints on the QE policy, namely, that it would not buy more than 70% of any issue of government debt; and that it would only buy traditional (non-index-linked) debt, with a maturity of more than three years. Originally, the bonds eligible for purchase were limited to UK government debt, but this was later relaxed to include high quality commercial bonds. QE was primarily designed as an instrument of monetary policy. The mechanism required the Bank of England to purchase government bonds on the secondary market, financed by the creation of new central bank money. This would have the effect of increasing the asset prices of the bonds purchased, thereby lowering yields and dampening longer term interest rates and making it cheaper for businesses to raise capital. The aim of the policy was initially to ease liquidity constraints in the sterling reserves system, but evolved into a wider policy to provide economic stimulus. Another side effect is that investors will switch to other investments, such as shares, boosting their price and thus encouraging consumption. In 2012 the Bank estimated that quantitative easing had benefited households differentially according to the assets they hold; richer households have more assets. In February 2022 the Bank of England announced its intention to commence winding down the QE portfolio. Initially this would be achieved by not replacing tranches of maturing bonds, and would later be accelerated through active bond sales. In August 2022 the Bank of England reiterated its intention to accelerate the QE wind down through active bond sales. This policy was affirmed in an exchange of letters between the Bank of England and the UK Chancellor of the Exchequer in September 2022. Between February 2022 and September 2022, a total of £37.1bn of government bonds matured, reducing the outstanding stock from £875.0bn at the end of 2021 to £837.9bn. In addition, a total of £1.1bn of corporate bonds matured, reducing the stock from £20.0bn to £18.9bn, with sales of the remaining stock planned to begin on 27 September. On 28 September 2022 the Bank of England issued a Market Notice announcing its intention to "carry out purchases of long dated gilts in a temporary and targeted way". This was in response to market conditions in which the sterling exchange rate and bond asset pricing were significantly disrupted following a UK government fiscal statement. The Bank stated its announcement would apply to conventional gilts of residual maturity greater than 20 years in the secondary market. The existing constraints applicable to QE bond purchases would continue to apply. The funding of the purchases would be met from central bank reserves, but would be segregated in a different portfolio from existing asset purchases. The Bank also announced that its annual £80bn target to reduce the existing QE portfolio remained unchanged but, in the light of current market conditions, the beginning of gilt sale operations would be postponed to 31 October 2022.

Eurozone

The European Central Bank engaged in large-scale purchase of covered bonds in May 2009, and purchased around €250 billion worth of sovereign bonds from targeted member states in 2010 and 2011 (the SMP Programme). However, until 2015 the ECB refused to openly admit they were doing quantitative easing. In a dramatic change of policy, following the new Jackson Hole Consensus, on 22 January 2015 Mario Draghi, President of the European Central Bank, announced an "expanded asset purchase programme", where €60 billion per month of euro-area bonds from central governments, agencies and European institutions would be bought. Beginning in March 2015, the stimulus was planned to last until September 2016 at the earliest with a total QE of at least €1.1 trillion. Mario Draghi announced the programme would continue: "until we see a continued adjustment in the path of inflation", referring to the ECB's need to combat the growing threat of deflation across the eurozone in early 2015. In March 2016, the ECB increased its monthly bond purchases to €80 billion from €60 billion and started to include corporate bonds under the asset purchasing programme and announced new ultra-cheap four-year loans to banks. From November 2019, the ECB resumed buying up eurozone government bonds at a rate of €20 billion in an effort to encourage governments to borrow more and spend in domestic investment projects. In March 2020, to help the economy absorb the shock of the COVID-19 crisis, the ECB announced a €750 billion Pandemic Emergency Purchase Programme (PEPP). The aim of the stimulus package (PEPP) was to lower borrowing costs and increase lending in the euro area.

Switzerland

At the beginning of 2013, the Swiss National Bank had the largest balance sheet relative to the size of its economy. It was responsible for close to 100% of Switzerland's national output. A total of 12% of its reserves were in foreign equities. By contrast, the US Federal Reserve's holdings equated to about 20% of US GDP, while the European Central Bank's assets were worth 30% of GDP. The SNB's balance sheet has increased massively due to its QE program, to the extent that in December 2020, the US treasury accused Switzerland of being a "currency manipulator". The US administration recommended that Switzerland increase the retirement age for Swiss workers to reduce saving assets by the Swiss social security administration, in order to boost domestic demand and reduce the necessity to maintain QE to stabilize the parity between the dollar and the Swiss franc.

Sweden

Sveriges Riksbank launched quantitative easing in February 2015, announcing government bond purchases of nearly US$1.2 billion. The annualized inflation rate in January 2015 was −0.3%, and the bank implied that Sweden's economy could slide into deflation. The Swedish Bank continued buying large amounts of government bonds through 2019. They then expanded QE policy through the COVID-19 pandemic in 2020 and 2021 and gradually brought down purchases by 2022.