Using Quantitative Easing to Stimulate the Economy

Quantitative easing (QE) is an economic strategy—monetary policy, wherein, the central bank deliberately buys financial assets or government bonds in large amounts to pump money directly into the economy. These financial assets are purchased from commercial banks and other financial institutions. By all implication, the prices of the financial assets will increase and their yield lowered while increasing money supply at the same time.

Nancy Davis, Portfolio Manager of the IVOL ETF and Founder of Quadratic Capital says defines quantitative easing as “an unconventional monetary policy tool used after conventional tools have become ineffective,”—a useful tool that has helped the US economy get out of the Great Recession and other relatable inflation issues.

It is an unconventional monetary policy used when the inflation levels are negative and the conventional monetary policy has become ineffective. Quantitative easing is quite different from the conventional monetary policy of buying or selling short-term government bonds to sustain the target value of interbank interest rates. By using the conventional monetary policy, the government is able to stimulate the economy by authorizing the central bank to buy short-term government bonds to decrease short-term market interest rates. This method becomes ineffective when short-term interest rates approach zero; the situation then becomes a ‘liquidity trap’.

In most cases, when this happens quantitative easing is introduced as a way to further stimulate the economy. In the threat of recession, quantitative easing is a useful tool that could be used to bring a country out of recession and also ensure that inflation levels do not drop below the central bank’s inflation target. On the contrary, if quantitative easing also proves ineffective to stimulate the economy, increased government spending can be used to further stimulate the economy.

The downside to quantitative easing, however, is that it can cause inflation due to the increased amount of money in circulation at a time. It can get worse if the central bank causes inflation through quantitative easing yet there is no economic growth which could lead to a ‘stagflation’ in the long run. Hopefully, this would not be the case with the coronavirus pandemic. The US government has taken several drastic economic measures towards stimulating the economy and ensuring that a recession doesn’t happen at all cost, yet there are still uncertainties about how long the outbreak would last.

The coronavirus pandemic yet again presents the US economy with another opportunity to engage the use of quantitative easing. On March 15, the Feds announced a $700 billion quantitative easing program in an attempt to fight the negative impacts of the coronavirus on the economy. This announcement came shortly after the Fed pledged $1.5 trillion short-term loans to commercial banks to boost the economy and fight the economic decline.