Saturday 30 April 2011

Quantitative easing


Quantitative easing is a monetary policy which is used to increase the money supply in an economy. It is often used once other monetary policies have proved ineffective and interest rates are either at, or close to, zero. It works by the central bank purchasing government bonds and other financial assets. Quantitative easing increases the money supply by flooding the financial system with capital, easing pressure on banks by giving them extra capital.

A central bank can do this by crediting its own account with money it has created out of nothing. It then buys government bonds, corporate bonds and other financial assests in “open market operations”. These purchases give banks the excess reserves required for them to create new money by “deposit multiplication” from increased lending in the fractional reserve banking system. This increase in money supply should therefore stimulate the economy.

There are however risks associated with this measure, one such risk being over effectiveness which could lead to hyperinflation. Another risk could be the measure not being effective enough, which could occur if banks decide to keep the additional capital in order to increase capital reserves.

2 comments:

  1. Please explain: "A central bank can do this by crediting its own account with money it has created out of nothing. "

    Also how can something be 'over effective'?

    Is this all the same as qualitative easing/

    ReplyDelete