What is Quantitative Easing?

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Quantitative easing is a monetary policy that central banks, such as the Federal Reserve, use to speed up sluggish economies.  In contrast to its counterparts, quantitative easing is used to manipulate the monetary base rather than the inter-bank interest rates, even though both are used to serve the same purpose in the end.

How Do Central Banks Use Quantitative Easing?

Quantitative easing is a simple process.  In short, central banks purchase treasuries and mortgage-backed securities from the financial institutions that hold them.

Since these financial institutions end up with an increase in funds, their willingness to lend increases at the same time.  This causes the inter-bank interest rates to fall, while also stimulating economic demand (because businesses have better access to funds through borrowing).

It is important to keep in mind that central banks cannot use quantitative easing unless they control the currencies used to purchase the securities.

Overall, quantitative easing remains useful even when circumstances render its more conventional counterparts ineffective.  Such counterparts typically focus on manipulating the inter-bank interest rates, which is not effective when rates are already very low. All told, quantitative easing is not without its complications and detractors.  For example, it can cause inflation and the devaluation of currency because it increases the supply of money.  Moreover, some have posited that quantitative easing benefits some sectors of the economy – and therefore society – more than others, leading to increased economic inequality.

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