What it means
Central banks normally steer the economy by moving a short-term policy interest rate up or down. When that rate is already at or close to zero, they need another tool, and quantitative easing is the main one.
The central bank credits itself with new reserves and uses them to buy bonds from banks, pension funds and other investors, which raises bond prices and lowers their yields. Lower long-term yields feed through to mortgage rates, corporate bond yields and the rates banks charge on business loans.
That makes it cheaper for a company to refinance existing debt, fund a new production line or issue fresh bonds to the market. It also tends to lift share prices and property values, because investors who sold their bonds go looking for returns somewhere else.
QE is announced as a purchase programme with either a monthly pace or a headline total, and the central bank's balance sheet grows by roughly the amount it buys. Analysts watch that balance sheet as a rough gauge of how much support is sitting in the financial system.
The effect is not mechanical, though, because a large share of the new money simply sits as reserves at commercial banks rather than turning into loans. It helps to separate QE from a government spending spree funded directly by the central bank, which is a different and far more inflationary arrangement.
QE swaps one financial asset for another; it does not hand cash to households. That distinction matters whenever a commentator claims the central bank is just printing money.
Critics argue that QE lifts asset prices more than it lifts wages, which widens the gap between people who own assets and people who do not. Supporters point to episodes where it kept credit markets open during severe stress and prevented a much deeper downturn.
Either way it is meant to be temporary, so every QE programme eventually has to be wound down.
In practice
Real-world examples.
Example
A regional housebuilder has $30 million of debt maturing next year and expects to refinance at 7%. A QE programme drags ten-year yields down by roughly a percentage point, and the builder locks in 6% instead, saving about $300,000 a year in interest.
Example
A pension fund sells $80 million of government bonds to the central bank as part of a QE operation. With the proceeds sitting in cash earning almost nothing, the fund shifts a large slice into investment-grade corporate bonds and listed infrastructure, which is exactly the portfolio rotation QE is designed to encourage.
Example
A mid-sized packaging manufacturer that had shelved a bond issue reopens the plan once QE compresses corporate spreads. It raises $120 million at a coupon it would not have seen a year earlier and uses the money to buy a competitor's plant.
Think of it
“QE is the central bank buying assets-printing money to stimulate the economy.
Formula
Calculation
Balance sheet expansion = monthly purchase pace x number of months.
Suppose a central bank announces asset purchases of $75 billion a month and runs the programme for eight months. Total purchases = $75 billion x 8 = $600 billion. If the balance sheet started the programme at $4.2 trillion, it finishes at $4.2 trillion + $0.6 trillion = $4.8 trillion. As a percentage, that is $600 billion / $4,200 billion = 14.3% growth in the central bank's holdings over eight months.Case study
Seen in the real world.
Northwind Ceramics is an illustrative, entirely fictional tile maker with $95 million of annual revenue and a heavy debt load left over from a factory rebuild. When a downturn hits, its bank signals that it may not roll over a $40 million facility, and the finance director starts modelling a fire sale of the newest kiln line.
The central bank then launches a large QE programme. Within four months, corporate bond spreads narrow sharply, and Northwind's bank, now flush with reserves and facing thin returns on government paper, offers to extend the facility at a lower margin instead of pulling it. The company refinances, keeps the kiln line and holds on to 210 staff.
The illustrative lesson is not that QE rescued Northwind on purpose. QE works on the whole credit market, and firms like Northwind are the indirect beneficiaries; when the programme was later unwound, the same firm had to plan for the reverse effect on its borrowing costs.
Watch out
Common mistakes.
- Treating QE as the central bank handing money to the public. The new money buys financial assets from investors, so it lands in the financial system first, not in household bank accounts.
- Assuming QE automatically causes runaway inflation. Much of the money created stays parked as bank reserves, and inflation depends on whether it actually turns into spending and lending.
- Reading a QE announcement as a signal to borrow immediately. Markets often price in the expected programme weeks before it starts, so the cheap rates may already be gone by announcement day.
Questions
People also ask.
Does QE lower the rate on my company's overdraft?
Not directly, because overdraft pricing is set by your bank's own margin and your credit risk, but QE lowers the underlying benchmark rates that most business loans are priced from.
How is QE different from a normal open market operation?
Normal operations are small, short-term and aimed at hitting a short-term rate target, while QE is far larger, aimed at long-term yields, and expands the balance sheet for months or years.
Who ends up paying for QE?
Nobody writes a cheque, but savers earn less on deposits and bond holders accept lower yields, so the cost lands on holders of safe, income-producing assets.
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