The world of finance and central banking is well known for its fondness of acronyms. Yet QE (Quantitative Easing) can be said to be the most famous of them all in the last decade or so. None has been as contentious, controversial, or open to different interpretations as QE. So, let’s begin.
The words “Quantitative Easing” tell us very little, rather unhelpfully, about what QE actually is. It is one of those grandiose, technical terms that can mean different things to different people in different contexts. So, to get a general understanding let’s start with a few authoritative definitions. The Bank of England provides a clear definition.
Quantitative easing is a tool that central banks, like us, can use to inject money directly into the economy.
Money is either physical, like banknotes, or digital, like the money in your bank account.
Quantitative easing involves us creating digital money. We then use it to buy things like government debt in the form of bonds.
You may also hear it called ‘QE’ or ‘asset purchase’ – these are the same thing.
The aim of QE is simple: by creating this ‘new’ money, we aim to boost spending and investment in the economy.
And this below is from the St. Louis Fed, part of the US Federal Reserve System (the US central bank):
Traditionally speaking, QE is when a central bank goes from targeting interest rates to targeting the amount of excess reserves held by banks, i.e., the quantity of currency in the banking system. Central banks do this by buying financial assets in exchange for reserves.
Conventional monetary policy also requires buying and selling assets, namely short-term debt, to influence the desired interest rate, but the difference with QE is that the level of purchases—and not the interest rate—becomes the target.
Britannica defines QE as:
A set of unconventional monetary policies that may be implemented by a central bank to increase the money supply in an economy. Quantitative easing (QE) policies include central-bank purchases of assets such as government bonds (see public debt) and other securities, direct lending programs, and programs designed to improve credit conditions. The goal of QE policies is to boost economic activity by providing liquidity to the financial system. For that reason, QE policies are considered to be expansionary monetary policies.
So, in sum QE:
• Is usually unconventional, exceptional, only used in times when other central bank policies are not delivering as expected
• Involves the creation of money by the central bank thus increasing the amount of money in an economy (expansionary monetary policy)
• This is then used to buy financial securities such as bonds and stocks
• This is then supposed to spur economic activity by increasing spending by firms and households and makes people “feel” wealthier
• This then signals to the market and the population that there is a buyer in the market with essentially unlimited firepower
Why is QE used?
There are several reasons why QE may be used. The economy may be in a bad state, with little confidence and low levels of economic activity. QE gives banks more liquidity which they can then lend or invest themselves in other assets (creating a wealth effect as prices rise and people and firms become richer). The central banks themselves also create this wealth effect directly when they push the price up of assets. For example, the Bank of Japan directly purchases Japanese stocks themselves.
Another reason is that most central banks have a legally mandated inflation target, usually around 2%. If inflation is below this for an extended period, and interest rates are already very low (like they are today in many advanced economies) then increasing the money supply, in theory, should push inflation back to target.
Perhaps more importantly, is the signalling effect, that these large-scale asset purchases provide. They tell the market that there is a buyer of last resort, with at least in theory, unlimited funds to support asset prices and the economy. This is meant to give confidence to the population and firms. The idea is then, with this confidence, economic activity will pick up again.
Why is QE so controversial?
For over a decade QE has been neither extraordinary nor exceptional. The US, UK, Japan, the European Central Bank and others have all utilised this one-time “emergency tool” frequently and almost consistently. For critics, QE is money printing in all but name. And looking at the Bank of England’s definition above it is hard to argue against that.
This leads to the question: why is printing money so bad? At a firm or personal level, it would seem absurd or crazy that expenses or debts could be paid by money that has just been conjured up out of thin air. That would essentially be like a person just issuing IOUs instead of cash and then these IOUs becoming accepted. Would you accept an IOU rather than cash?
This is where supporters of QE argue that it is not the same for a government or central bank. Because central banks and governments, in theory at least, cannot go bankrupt because they have unlimited funds, and because they control the currency itself, the analogy to households and firms is misplaced. This is also the argument for Modern Monetary Theory.
Yet, at a philosophical level, the appearance of money printing is in contrast to prudent risk-taking capitalist economies. After all, if a government borrows and borrows but can then pay that debt back in newly created money, rather than tax receipts or issuing new debt, what is the true value of the economy? And why should any of us pay taxes?
As history has taught us, countries that have embraced this strategy have devalued their currencies to almost nothing, leading to hyperinflation and the collapse of economies. History is littered with failed currencies once the money-printing spirals out of control.
However, the issue now is that QE has become economic orthodoxy. Almost every major central bank has utilised QE since the financial crisis. So, what is being devalued exactly? The hyperinflation that many predicted never came. Not yet at least. Yet is this a reason to keep doing QE?
For many, the problems outweigh the supposed benefits. The market is meant to be the price setter of all goods, services and assets based purely on demand and supply. But if there is a behemoth central bank waiting in the wings to buy assets, or indeed already buying assets, then how does one know what the value of something really is? How does one know what the real supply and demand actually is? And if this is not clear is capital being allocated to the areas where it is really needed?
Another criticism is that QE creates unnecessary risk-taking, that it perverts the usual economic incentives by bailing out, either directly or indirectly, companies that in a “normal” environment would have gone bankrupt. Thus, it is as seen as socialism for elites and established corporations while smaller businesses and individuals appear to benefit less. This creates political problems.
Indeed, a critical component of capitalism and democracies in general, is the acceptance of failure and mistakes. These can then be corrected (inefficient businesses fail / governments are voted out) and lessons are learnt from these failures and hopefully not repeated. Many argue QE prevents real price discovery and helps cover up failure.
And while there has been little inflation at a consumer level. Asset prices such as stocks, bonds and property have soared. This is also due to low-interest rates as investors look for better returns than leaving their savings in cash. If you know that QE is taking place, and that central banks are propping up asset prices it is appealing to invest in the assets that are being supported. This has also led to accusations that QE only helps asset owners and not the general population and thus contributed significantly to income inequality, not only within wealthy countries but also globally.
Global GDP is roughly between USD80-90 trillion. If we look at how much QE has been done since the financial crisis of 2008 the figure is a significant proportion of that:
As can be seen, the idea that QE is exceptional has gone out the window. Central bank balance sheets are now almost USD20 trillion – a huge number versus global GDP.
The idea originally was that once the economy recovered central banks would then reverse QE. However, very few economists think this is possible with the state of the economy as it is, especially after the hit of the pandemic.
What seems more likely is that as the economy recovers there should be, in theory, less need for QE. But the world is in unchartered territory.
There is also now the expectation that whenever there is a crisis, central banks will come riding to the rescue. But at what point does the efficacy of QE lose its power? And what happens if inflation rates really start to move higher?
After all, the long-term picture is a world with roughly 3 billion more people by 2050. These people will expect a far higher standard of living than many have now. Even with some areas showing poor demographics the trend is clear. Demand for goods and services will soar. Can QE really be an effective policy in an inflationary environment?
It is clear that QE involves increasing the money supply, by essentially printing money. As this happens currencies become debased and devalued in terms of their purchasing power. This has not yet happened with basic living goods but has happened with property, stocks and other assets.
History has shown that once this pandora’s box is opened it is very difficult to close. The consequences of the last 13 years are yet to be really understood but for many economists, though not all, QE can do real and lasting damage to the way an economy operates and thus how society functions.
It is therefore unsurprising to see demand for gold remain strong in an environment where QE is all but expected instead of being used solely as an emergency mechanism.