Advantages of Quantitative Easing

The strategy of quantitative easing is a new tool being used by Central Banks all over the world. Most big central banks like the Fed, Central Bank of England, European Central Bank and the Bank of Japan have been using this strategy extensively as of late.

This tool has been used on such a grand scale that there is a belief that if the consequences do not work out as intended, it could bring down the entire system along with it. So then what is it that is keeping the governments and the central banks hooked to the use of quantitative easing? In this article, we will have a look at some of the advantages of quantitative easing:

Additional Tool

Quantitative easing is a new tool that is at the disposal of the Central Bankers. Earlier, the Central Bankers could only resort to interest rate changes to influence the economy. For instance, when the economy was low, they would lower the interest rates, spurring lending and other economic activity. They would do the converse when the economy was high and needed to be brought down.

However, in the recent crises like the ones in Japan and the United States, the interest rates had already been reduced to sub zero levels. Hence, the government had no probable course of action, in case they wanted to spur the economy. In cases like these, quantitative easing (QE) comes in handy. This is because it acts as an additional tool in the kit of the government and helps the Central Bankers mitigate crises when they happen.

Lowers Interest Rates

The main effect of quantitative easing (QE) is that it increases the monetary base i.e. the money supply of the system. A higher money supply has always been linked to a fall in the interest rates. This is because excess money starts flowing into the system and then lenders have to compete with each other to lend that excess money. In the process of this competition, they drag the interest rates down. Hence, quantitative easing (QE) as a tool becomes double as effective.

By introducing quantitative easing (QE) the other objective of monetary policy i.e. to lower interest rates is automatically achieved! A lower interest rate further supports an expansionary monetary policy causing the boom phase to grow bigger. In the short run quantitative easing (QE) may almost seem like it is too good to be true.

Prevents Unemployment

Economic crises are usually followed by epic unemployment. For instance, the Great Depression of 1929 is one of the worst periods in economic history. More that 40% of the people were unemployed during that time.

The unemployment stretched for many years before the economy became normal. However, in modern day crises, unemployment has seldom been seen stretching so long and affecting so many people. This can be partly attributed to the economic policy of quantitative easing (QE). This policy has ensured that the employment rates do not fall down so drastically so stay down for so long.

Hence, in the short run, the policy of quantitative easing (QE) has been extremely beneficial to the average person because it has protected their jobs. Otherwise, the crisis of 2008 was enough to create a prolonged period of unemployment.

Drains Toxic Assets

In the policy of quantitative easing (QE), the Central Bank buys assets from the open market. It does so by using newly created money and hence injects this money into the system. Now, the assets purchased by the central bank could be anything. Usually they are government bonds because this increases the liquidity of the market for government bonds and also because they tend to be the safest.

However, in cases like the subprime mortgages, the government could have also purchased the toxic assets via a quantitative easing (QE) program. This drains the toxic assets out of the system and puts them in closed vaults of the central bank. Once the crisis begins to resolve itself, these toxic assets are slowly released into the economy wherein they can be quickly absorbed and do not disturb the equilibrium of the entire economy.

Immediate Results

The best part about the policy of quantitative easing (QE) is that it provides immediate results. As and when a crisis hits the economy, the government can simply start quantitative easing. As a result, quantitative easing is considered to be the most preferred solution by governments all over the world. This is because it can be easily applied as a quick fix.

It might be a sad thing to know but the economic policies of the world are decided based on political motives. Therefore, quantitative easing which is a great political strategy since like the painkillers it provides instant relief from the problems is considered to be highly effective.

Government Control

Another plus point that works in favor of quantitative easing is the fact that the government has virtually 100% control over the outcomes.

In case the central bank cuts interest rates, it is then dependent on the member banks to pass on these interest rate cuts to the final consumers in the form of increased lending.

However, in case of quantitative easing, the government has 100% control over the outcome of the exercise. Since they are buying bonds, they know the exact amount of money that they are circulating in the marketplace and how it will affect employment, consumer confidence and the economy as a whole.

These perceived benefits are what make quantitative easing one of the most preferred methods of monetary interference by the Central Banks today. However, these benefits have been highly critiqued and questioned and many feel that there are no advantages to quantitative easing, rather there are massive disadvantages. In the next article, we will have a look at some of these disadvantages.