The influence of central banks on the economy should never be underestimated. One of the primary methods to keep economies afloat comes in the form of quantitative easing, or QE.
The Common Monetary Policy
Most central banks around the world currently maintain the QE strategy. It is a way for these institutions to purchase assets on a very large scale. In most cases, they look to acquire government bonds or other common assets to bring more liquidity to an economy. This is the direct opposite of quantitative tightening, or QT.
These assets are often purchased from commercial banks. As a result of these buying sprees, the prices of those assets often tend to rise accordingly. Unfortunately for investors, that also means the yield of these assets will decrease heavily.
Under normal circumstances, quantitative easing would never be utilized unless there is negative or low inflation. However, virtually all central banks around the globe have flocked to this standard following the financial crisis of 2008.
The Possible Consequences
No strategy in the financial world comes without its own set of risks. Quantitative easing is no different in this regard. Enforcing such a policy can be a double-edged blade. If it works well, there is no problem. If it works too well, however, it can trigger higher inflation rates than before.
There is also a scenario during which QE doesn’t work at all. This usually occurs when banks aren’t willing to lend money, or borrowers show no real demand for loans. It is a very tough balancing act to juggle, and one that needs to be monitored around the clock.
Quantitative Easing: Inner Workings
Assuming quantitative easing goes as planned, there are several interesting consequences.
First of all, it banks cheaper for banks to extend loans to consumers or small businesses alike. That is a good thing, assuming there is a need for more loans at that time.
Secondly, investors who are on the wealthy side of the spectrum are not a big fan of QE practices. More often than not, they will be forced to rebalance their portfolios. This is either due to lower interest rates, or by forcing investors to look into other financial security vehicles.
The exchange rate of a national currency will also undergo fluctuations during a period of quantitative easing. As the money supply in the region “grows”, the exchange rate often plummets. If this is a slight dip, there is no real cause for concern. When left unchecked, however, the domestic exchange value of the domestic currency can go down a slippery slope pretty quickly.
A Relatively Common Practice
Although the term QE isn’t often mentioned in mainstream media, the practice is relatively common among central banks. In the US, the first QE measures were implemented in the 1930s following the Great Depression.
A similar measure was taken by the Bank of Japan in the early 2000s. The country suffered from severe deflation at that time. It took the bank until February of 2001 to finally change its stance and embrace QE as a possible countermeasure. Until that point, the BOJ had no interest in deploying this policy.
Since the year 2008 – and the associated financial crisis – the use of quantitative easing has exploded. The US, UK, and most of the Eurozone quickly introduced measures to stimulate their respective economies.
A Force of Habit?
Ever since that time, the Federal Reserve has implemented multiple QE measures. A second round was introduced in late 2010, followed by the third in September 2012. All of these measures eventually came to an end in late October of 2014.
The US is not alone in this regard. Even in the UK, the asset purchasing process remained in effect for multiple years. Quantitative easing measures were expanded upon multiple times. Even today, it seems that these measures are still in effect.
A similar scenario unfolded in the Eurozone. The ECB is still purchasing bonds every single month as part of its QE countermeasures.
Sweden began its quantitative easing in 2015 courtesy of Sveriges Riksbank. These measures were never taken out of the equation completely. There are still some concerns as to how deflation could affect the Scandinavian region in the years to come.