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Learn · The economy· Intermediate · 6 min

Quantitative easing

A central bank creating money to buy bonds. Easier to understand than its reputation suggests, and harder to reverse.

When short-term interest rates are already near zero, a central bank wanting to loosen further has run out of its usual lever. Quantitative easing is what it reaches for next.

The mechanism

  1. The central bank creates reserves — money that exists only in the banking system.
  2. It uses them to buy assets, typically government bonds, from banks and other holders.
  3. Buying bonds raises their price, which lowers their yield.
  4. Lower long-term yields reduce borrowing costs across the economy, and push investors towards riskier assets in search of return.
Fact
It is not the same as printing money for the government to spend
The central bank buys bonds that already exist, usually on the open market, exchanging one financial asset for another. No money is handed to the treasury to spend. The distinction is genuine, and it is also true that the line blurs when purchases are very large and sustained.

What it was trying to fix

Two things: lowering long-term rates when short rates could go no lower, and signalling that policy would stay loose — which shapes expectations, which is half of what monetary policy does.

The criticisms worth taking seriously

  • Asset prices. Pushing investors towards riskier assets raises their prices, which benefits people who already own assets.
  • Distribution. That effect is uneven by design, since asset ownership is uneven.
  • Exit. Accumulating a very large balance sheet is straightforward. Reducing it without disrupting markets has proved harder.

Quantitative tightening

The reverse: allowing bonds to mature without reinvesting, or selling them, shrinking the balance sheet and withdrawing reserves. It puts upward pressure on long yields, and it has generally been done cautiously because its effects are less well understood than the easing that preceded it.

Interpretation
Both directions are experiments with short track records
Large-scale asset purchases have only been used widely since 2008. The evidence on how much they achieved, and on what unwinding them does, is far thinner than the confidence with which both are usually discussed.
If you hold bonds or a bond fund, these programmes are among the largest single influences on their price — a buyer of that size changes the market simply by being in it.
Next lesson How banks create money →
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