What is quantitative easing?
- 13 July 2016
- From the section Business
Governments and central banks like there to be "just enough" growth in an economy - not too much that could lead to inflation getting out of control, but not so little that there is stagnation. Their aim is the so-called "Goldilocks economy" - not too hot, but not too cold.
One of the main tools they have to control growth is raising or lowering interest rates. Lower interest rates encourage people or companies to spend money, rather than save.
But when interest rates are at almost zero, central banks need to adopt different tactics - such as pumping money directly into the financial system.
This process is known as quantitative easing or QE.
How does it work?
The central bank buys assets, usually government bonds, with money it has "printed" - or, more accurately, created electronically.
It then uses this money to buy bonds from investors such as banks or pension funds. This increases the overall amount of funds in the financial system. Making more money available is supposed to encourage financial institutions to lend more to businesses and individuals. It can also push interest rates lower across the economy, even when the central bank's own rates are just about as low as they can go. This in turn should allow businesses to invest and consumers to spend more, giving a knock-on boost to the economy.
What are the risks?
The biggest concern is that pumping more money into the economy could ultimately lead to an inflation problem.
When inflation is close to zero, as it is in the UK and the eurozone at the moment, a bit more upward pressure on prices can be seen as a good thing. But some politicians and economists have opposed the idea of QE in principle, because they believe in the long run there's a danger that it could create too much inflation.
Others argue that the extra money has just bolstered the price of some assets such as shares and property in some countries.
Who has tried QE?
Both the Bank of England and the US Federal Reserve embarked on QE in the wake of the 2008 financial crisis in an attempt to stimulate economic growth.
Between 2008 and 2015, the US Federal Reserve in total bought bonds worth more than $3.7 trillion.
The UK created £375bn ($550bn) of new money in its QE programme between 2009 and 2012.
The eurozone began its programme of QE in January 2015 and has so far pumped in $600bn of extra money. Originally the programme was set to run until September 2016, but it has now been extended until at least March 2017.
QE was first attempted by Japan's central bank to arrest a period of deflation following its financial turmoil in the 1990s. There is disagreement about whether the initiative had the intended effect of stimulating the Japanese economy.
Has QE worked?
Its effect is hotly contested and hard to measure. Over the last few years, the US economy has stabilised and unemployment has fallen steadily. Some credit QE for the recovery, at least in part.
European Central Bank governor Mario Draghi said in June 2015 that the policy had "contributed to a broad-based easing in financial conditions, a recovery in inflation expectations and more favourable borrowing conditions for firms and households".
In the UK, it was introduced for similar reasons and it has been argued that its introduction helped credit conditions and overall financial stability.
Are there any losers from QE?
QE pushes up the market price of government bonds and reduces the yield, or interest rate, paid out to investors. In other words, investors have to pay more to get the same income.
If market interest rates are lower that depresses the value of a currency because it becomes less attractive to foreign investors.
The US's programme of QE also kept the value of the dollar lower than it might otherwise have been, a factor not welcomed in some emerging economies. Since the end of QE in the US and with the prospect of interest rate rises there, the dollar has regained strength.