Quantitative Easing (QE2) is a monetary policy tool used by the central banks to increase the supply of money in an economy when the bank interest rate, discount rate and/or interbank interest rate are either zero or close to zero. Usually government regulates interest rates to increase or decrease the money supply in the country. As lower interest rates encourage people to spend more, government reduces the interest rates to increase money supply. But when interest rates can no longer go lower For Example, if the interest rate is 0.25% then the central bank pumps direct money into the banking system which is called as Quantitative Easing.
In other words, under quantitative easing, central banks (RBI in India) pumps new money in the banking system to encourage banks to lend. As it increases the liquidity of the banks, hence the lending power. A central bank does this by creating ‘New Money’ and then crediting the same into the banking system by purchases financial assets, including government bonds and corporate bonds, from banks and other financial institutions in the country. This is done by central banks through what is popularly known as open market operations, which is a term used for “buying and selling government bonds.” They doesn’t physically print money. Instead it electronically changes its bank balances.
[ Image Credit : Flickr ]
Process Of QE?
- The Central bank creates ‘New Money’ electronically in its accounts
- The Bank buys government and corporate bonds from commercial banks with the newly created money.
- The value of the bonds bought from banks is now credited to there accounts. (It increases liquidity of banks. hence increases the power to lend more)
- Extra lending boosts cash and credit flowing in the economy.
- Flows of extra and cheaper money stimulate the economy growth
What Are The Benefits Of QE?
- Growth: Flow of extra and cheaper money will stimulate growth of the country.
What Are The Risks Of QE?
- Inflation. When economy recovers it might be difficult to take out the excess money supply out from the economy causing uncontrollable inflation.
- The value for the currency will be devalued in the international market.