Quantitative easing

Quantitative easing is a tool of monetary policy. It effectively means that the central bank injects new money into the financial system, in order to increase the supply of money. 'Quantitative' refers to the money supply; 'easing' refers to reducing the pressure on banks. A central bank can do this by buying government bonds (Treasury securities in the United States) in the open market, or by lending money to deposit-taking institutions, or by buying assets from banks in exchange for currency, or any combination of these actions. These have the effects of reducing interest yields on government bonds, and reducing inter-bank overnight interest rates, and thereby encourage banks to loan money to higher interest-paying bodies. In layman's terms, the central bank creates more money (a liability for the central bank) and uses this money to buy securities in the open market (an asset). As of 1998, the US Federal Reserve held about 40% of US government debt.

Quantitative easing was used notably by the Bank of Japan (BOJ) to fight domestic deflation in the early 2000s. More recently during the global financial crisis of 2008, policies announced by the US Federal Reserve under Ben Bernanke to counter the effects of the crisis have been likened to quantitative easing coupled with the issuance of new debt on the US federal balance sheet.

In Japan's case, the BOJ had been maintaining short-term interest rates at close to their minimum attainable zero values since 1999. With quantitative easing, it flooded commercial banks with excess liquidity to promote private lending, leaving them with large stocks of excess reserves, and therefore little risk of a liquidity shortage. The BOJ accomplished this by buying more government bonds than would be required to set the interest rate to zero. It also bought asset-backed securities, equities, and extended the terms of its commercial paper purchasing operation.

Willem Buiter has proposed a terminology to distinguish quantitative easing, or an expansion of a central bank's balance sheet, from what he terms qualitative easing, or the process of a central bank adding riskier assets onto its balance sheet:

"Quantitative easing is an increase in the size of the balance sheet of the central bank through an increase it is monetary liabilities (base money), holding constant the composition of its assets. Asset composition can be defined as the proportional shares of the different financial instruments held by the central bank in the total value of its assets. An almost equivalent definition would be that quantitative easing is an increase in the size of the balance sheet of the central bank through an increase in its monetary liabilities that holds constant the (average) liquidity and riskiness of its asset portfolio."

"Qualitative easing is a shift in the composition of the assets of the central bank towards less liquid and riskier assets, holding constant the size of the balance sheet (and the official policy rate and the rest of the list of usual suspects). The less liquid and more risky assets can be private securities as well as sovereign or sovereign-guaranteed instruments. All forms of risk, including credit risk (default risk) are included."

See also

• Economic history of Japan
• Economy of Japan

External links

• Deflation: Making Sure "It" Doesn't Happen Here, 2002 speech by Ben Bernanke on deflation and the utility of quantitative easing