August 21, 2014

Quantitative Easing

Quantitative Easing is a term that is getting regularly thrown about in these difficult times, but the key question is what is it? This section aims to explain the concept of Quantitative Easing and how it can act as a stimulus for economic growth.

The practice of Quantitative Easing usually comes into play in order to boost the flow of money within an economy. It is looking to ease the pressure on an economy, by injecting more money into it. It is usually initiated because interest rates can’t be cut any further, as they are already low enough and to help achieve the target rate of 2% inflation.

Quantitative Easing – what happens?

The central bank raises money electronically and uses that money to purchase assets, usually both government and commercial bonds from banks. A central bank will issue central bank reserves in order to buy the respective bonds. Banks who are selling these assets to the central bank, now benefit from an increase in available cash which theoretically should encourage them to lend greater amounts to people. Likewise, the price of bonds increases due to the demand created and this should bring down interest rates on bonds, which makes them look less appealing and boosts spending.

So all in all, Quantitative Easing looks to stop banks holding onto their money and buying bonds and treasuries, instead distributing a new round of cash to businesses and people in order to ramp up spending within the economy.

Quantiative Easing – the potential problems

QE is not without its potential problems. If there is too much money floating around within the economy, then this may cause the pound to be devalued. Moreover, there is a chance that the increasing availability of cash could push prices up and result in inflation due to high demand. Similarly, these concerns about inflation could deter investor confidence in the market as a whole.