ET in the classroom: What is Quantitative Easing?

Central banks usually stimulate a slowing economy by cutting interest rates, which encourages people to spend by borrowing more. But with rates in the developed world already close to zero, that option is no longer available.

So central banks pump money directly into the economy, a process known as quantitative easing.

How is this done?
Central banks expand their balance sheets by buying government securities or other securities from the market and financial institutions.

This process increases the money supply by flooding financial institutions with capital, in an effort to promote increased lending and liquidity.

Has this been done earlier?

Developed countries used quantitative easing to spur growth following the 2008 financial meltdown.

Subsequently, the US Fed went ahead with another round of QE in late 2010 (called QE2).


Other central banks such as the Bank of England and Bank of Japan have also increased money supply via QE in the past two years.


How does it work?
At any given point of time, there is a fixed amount currency/money chasing products and services available in the economy.

The objective is to get more money into the system and promote consumption.

The intention is also to spur lending by giving more cash in the hands of financial institutions.


How does it help?
The flood of cheap money causes asset (shares and real estate) prices to rise.

The notional high wealth, together with cheap and easy credit, encourages people to spend.

Quantitative easing also helps devalue the currency, encouraging exports further and increasing the level of economic activity.

The final consequence is increased demand resulting in ramping up of production, which, in turn, creates more jobs.

What will be the impact of another QE?
In today's globalised world, cheap money from developed economies may flow into emerging economies and fuel asset bubbles and inflation by perking up commodity prices.

While India is in dire need of dollar inflows the positives are offset by rising commodity prices.