Quantitative easing Facts for Kids

Quantitative easing (QE) is a monetary policy action where a central bank creates new money to buy things like government bonds, with the goal of encouraging more borrowing and lending.

A central bank is a special bank that helps manage a country's money. It's like the captain of a ship, making sure the economy stays on course. When the economy is struggling, the central bank can use different tools to help. One of these tools is quantitative easing.

Quantitative easing involves the central bank creating new money. It doesn't print physical cash, but rather adds money to the accounts of banks and other financial institutions. Then, the central bank uses this new money to buy things like government bonds or other assets from these banks.

Government bonds are like IOUs that the government sells to raise money. When the central bank buys these bonds, it gives the banks more money to lend out to people and businesses. This can help encourage more borrowing and spending, which can boost the economy.

Why do central banks use QE?
How does QE work?
History
Does QE always work?
Risks and side effects
What are the alternatives?
Images for kids
See also

Why do central banks use QE?

Central banks usually use quantitative easing when the economy is facing a recession or when inflation is very low. A recession is when the economy slows down and businesses struggle. Inflation is when prices for things like food and gas go up.

When interest rates are already very low (close to zero), it becomes difficult for the central bank to lower them further to stimulate the economy. This is where quantitative easing comes in. By creating new money and buying assets, the central bank hopes to lower borrowing costs, increase lending, and encourage more spending.

How does QE work?

Quantitative easing works through several channels:

Credit Channel: By giving banks more money, QE makes it easier and cheaper for them to lend to companies and people. This helps businesses grow and allows people to buy things like houses or cars.
Portfolio Rebalancing: When the central bank buys government bonds, it takes those safe assets out of the market. This can encourage investors to buy other types of assets, like stocks or corporate bonds. This can help lower the interest rates on those assets, making it cheaper for companies to borrow money.
Exchange Rate: QE can also affect a country's exchange rate. When a central bank creates more money, it can make the country's currency less valuable compared to other currencies. This can make the country's exports cheaper and more attractive to buyers in other countries.
Fiscal Effect: By lowering interest rates on government bonds, QE makes it cheaper for the government to borrow money. This can allow the government to spend more money on things like infrastructure or education, which can help boost the economy.
Boosting Asset Prices: When a central bank buys government bonds from a pension fund, the pension fund might use that money to invest in other assets, like stocks. This increased demand for stocks can drive up their prices, making businesses and households that own stocks wealthier. This can encourage them to spend more, further boosting the economy.
Signaling Effect: QE can also send a signal to the markets that the central bank is serious about helping the economy. This can boost confidence and encourage more investment and spending.

History

Quantitative easing is a relatively new tool, but it has been used by several countries in recent years.

Japan (2001-2006)

The Bank of Japan was the first central bank to use quantitative easing in the early 2000s to fight deflation (when prices go down).

United States (2008-2014, 2020)

The Federal Reserve (the central bank of the United States) used quantitative easing during and after the 2007-2008 financial crisis and again in 2020 in response to the COVID-19 pandemic.

November 2008: The Federal Reserve started buying $600 billion in mortgage-backed securities.
November 2010: The Fed announced a second round of quantitative easing, buying $600 billion of Treasury securities.
September 2012: A third round of quantitative easing was announced, with the Fed buying $40 billion per month of agency mortgage-backed securities.
March 2020: The Federal Reserve began its fourth quantitative easing operation, announcing approximately $700 billion in new asset purchases to support US liquidity in response to the COVID-19 pandemic.

United Kingdom (2009-2020)

The Bank of England also used quantitative easing to help the UK economy recover from the financial crisis.

Eurozone (2015-2018, 2019-2020)

The European Central Bank (ECB) launched a large-scale quantitative easing program in 2015 to combat deflation and stimulate the Eurozone economy.

Switzerland

The Swiss National Bank also engaged in quantitative easing.

Sweden

Sveriges Riksbank launched quantitative easing in February 2015.

Does QE always work?

The effectiveness of quantitative easing is a topic of debate among economists. Some studies suggest that it can help lower interest rates, boost economic growth, and increase inflation. Other studies are less conclusive.

One potential problem with quantitative easing is that it can lead to higher inflation if too much money is created. On the other hand, it might not be effective if banks are reluctant to lend money or if people and businesses are unwilling to borrow.

Risks and side effects

Quantitative easing also has some potential risks and side effects:

Inflation: If the central bank creates too much money, it can lead to higher inflation.
Inequality: Some critics argue that QE can benefit the wealthy more than the poor, as it can drive up asset prices like stocks and real estate.
Impact on Savings and Pensions: Low interest rates caused by QE can hurt savers and pension funds, as they earn less money on their investments.
Effects on Climate Change: Some people argue that QE can indirectly support polluting companies if central banks buy their bonds.
International Spillovers: QE can affect exchange rates and have consequences for other countries, especially emerging economies.
Moral Hazard: Some worry that QE can encourage governments to borrow too much money, as it makes borrowing cheaper.
Reputational Risks: If a central bank is seen as printing money to finance government debt, it can damage its credibility.

What are the alternatives?

If quantitative easing isn't the best solution, what else can be done to help the economy? Here are a few alternative ideas:

QE for the People: Instead of giving money to banks, some people suggest giving it directly to households. This could encourage more spending and boost the economy.
Fiscal Policy: This involves the government spending money on things like infrastructure or education. This can create jobs and stimulate economic growth.
Monetary Financing:This is when the central bank directly finances government spending. However, this is often seen as risky, as it can lead to high inflation.
Neo-Fisherism: This is a controversial idea that suggests raising interest rates to combat low inflation.

Images for kids

Federal Reserve holdings of treasury notes (blue) and mortgage-backed securities (red)
Increase in US Federal Reserve assets in response to COVID-19 pandemic
Immediate and delayed effects of quantitative easing