What the hell is Quantitative Easing? Never understood it properly.
In: Economics
Without the technicality, QE is a method for Central Banks to quickly introduce more money into the economy. Most money is created electronically nowadays – people call it a printing press but very little of the money circulating in the economy are actual notes or coins.
More technically, a Central Bank simply creates money by adding it to the bank account of banks in exchange for assets (mostly govt bonds but in some cases mortgage backed securities, corporate bonds and even shares in some companies). Unlike normal organizations/individuals, the Central Bank doesn’t need money in their accounts to buy things, it simply creates the money by depositing the amount in the seller’s account.
Central Banks are a bank that all other private banks must open cash accounts with and that used to be pretty much it. All other banks must deposit a certain amount of money in their account at the Central Bank. Generally, Central Banks don’t buy or own assets from the open market. All they hold are cash accounts. By controlling interest rates and the amount of deposits needed from other banks, the Central Bank essentially conducts monetary policy (money supply and interest rates)
This system works because, presumably, private banks want to maximize their profits by issuing new loans with their remaining funds/assets (after depositing the required cash amount in the CB)
In times of crisis, banks have too many loans outstanding (a loan to private entities is considered an asset by the bank) and have to limit the amount of new loans/credit they can issue to manage internal risk. Coupled with very low interest rates, banks may lose the incentive to issue loans/credit. This is bad for an economy because nearly all trade and economic activity requires some form of credit – essentially economic activity is reduced simply because private actors have no access to money/credit.
In recent decades, QE is a new policy tool to quickly FORCE (essentially) more money into the market. By buying up assets from banks, the banks now have a lot of cash (which earn very low interest from the CB) and fewer higher-interest assets but correspondingly lower risk of default (all loans have a default risk whereas money is considered risk-free) This gives incentive to the bank to make more loans to the general public.
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