Quantitative Easing

Strange things happen with all of us. And stranger things happen with me. Met a close friend after a long time and one thing lead to another and we found ourselves at one of the numerous bars in the CP.  And man, that lady with a kid sitting opposite us , well, took most of the time. Cute, she was (here, I am at a risk of a fight, if you know what I mean! ). 

Somehow, between Afridi sending balls out of the park and the occasionally smiling lady, we drifted to the issue of printing money and what happened in Zimbabwe when they started printing dollars worth a Hundred trillion dollars and how it was good enough only to buy, hold your breath, an Egg! So much for a trillion dollars! 

So, what happened there? Of course, there is something called Hyperinflation and of course, we will discuss it sometime later on, for sure. What really got us talking, forgetting that lady in the process was the fact that he was sure that this is what happens when Quantitative easing is done! That alarmed me, because nothing can be farther from the truth, though it does involve printing more money sometimes and releasing more money into the economy. However, hyperinflation and QE doesn’t always go together. In fact, both are characteristics of two very different economies. The former is, more often than not, a feature of poorer economies while the later is almost exclusive to developed and richer ones.

Without much ado, let’s jump to the issue at hand. So, what exactly is quantitative easing? It’s not the crazy money printing exercise that Weimar Germany and Zimbabwe indulged in, that led to hyperinflation.  Strictly speaking, QE is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital, in an effort to promote increased lending and liquidity.  Central banks tend to use quantitative easing when interest rates have already been lowered to near 0% levels and have failed to produce the desired effect
Whoa! What was that?  Seriously, why do they define economic terms in such huge, well, terminologies? That’s another question to ponder though. Coming back to QE, in simple terms it is releasing more money into the market to stimulate more lending  and in general terms, to stimulate growth . Imagine your dad giving you more  money so that you could buy more books to study by selling some of the Kisan Vikas Patra’s he had or to understand better, selling that old scooter to somebody who is willing to  buy it.  

Now, just inflate the stakes involved. You turn into a economy where the lending rates are so low that nobody is willing to lend and as such, no money in the market to produce new goods or to install new factories, even if that’s what best for you(Economy) (Compare this with you having no money to buy new books, even though you desperately need it). Your dad, here, becomes (And Don’t come back to me saying how come you objectify my dad!) the financial institutions and the private companies who have bonds they want to sell so that they can raise some cash(Which is hard to come by !), though nobody is willing to buy since the yield (interest rate) is so low. The Central bank then becomes your dad’s good friend who starts buying those bonds, thus giving the Financial Institutions and also private companies desperately needed cash and kicks off the economy into motion!  The following figure gives a good illustration of the process!  (And They said cartoons are for kids! Huh!)

Now, the question is:  So, where does this money come from? More often than not, central bank does print more money to pump into the economy, but as earlier said, it’s not blind printing and distributing the same. This money is used to buy bonds of debts from private companies and govt. ones too!

Let’s get a  bit more technical now!  At its core, quantitative easing is the attempt by a central bank to inject more money into the economy and to keep long-term interest rates low through the purchase of large amounts of assets, often held by financial institutions. In March 2009, for instance, the Bank of England, the U.K.’s central bank, engaged in quantitative easing by buying U.K. government bonds as well as debt issued by private companies. The means those firms now have more cash on their hands, which in theory makes business lending easier. 

The Federal Reserve (in the US of A) undertook a large quantitative easing measure by buying about $1 trillion in long-term Treasury bonds in March 2009. Taking bonds out of circulation might raise demand for the bonds left in the market, hence raising their prices and lowering their yields (bond prices and yields move in opposite directions) because the bond issuers do not have to promise higher yields in order to entice buyers. These lower rates should make further business investment more likely(Yeah, it is a circle , I know :D).

The major risk of quantitative easing is that, although more money is floating around, there is still a fixed amount of goods for sale. This will eventually lead to higher prices or inflation.  The other issue is that it is difficult to gauge how much money to be injected  into the economy so that there is a balance between it’s positive and negative effects. However, in economies where  deflation is a major concern and the economy is not growing(Say, Japan!), inflation will actually be a welcome change which will push up production and set the demand supply cycle into motion, giving a huge smile on the face of the central banks and the industry!

So, If I were to give you a better Idea, I would use the following:

I hope I have helped you understand what QE is! Comments and Criticism are welcome! So are any suggestions for new articles!