Quantitative Easing (QE): Meaning, Importance, and How it Works

Quantitative Easing, or QE, is a monetary policy central banks implement to stimulate economic growth. QE involves central banks purchasing securities like government bonds and financial assets from commercial banks in the open market to increase the overall money supply in the financial system and reduce long-term interest rates.

Quantitative easing was first introduced by the Bank of Japan (BoJ) in 2001, and the Fed began using it in 2008.

Central banks like the United States Federal Reserve (Fed) turn to quantitative easing when economic growth is stunted and traditional intervention methods like lowering interest rates have failed.

QE aims to lower borrowing costs, encourage banks to lend to businesses and individuals, lead to more investments, and allow higher consumer spending.

The quantitative easing definition is popular in finance because it affects the behavior of financial markets including forex, stocks, bonds, commodities, etc. Investors and long-term investors must understand QE as they learn forex trading terms because it’s a crucial component of fundamental analysis.

The Fed began using QE in November 2008 as a response to the 2007–2008 financial crisis, which culminated in the Great Recession. Many economists consider this first QE by the Fed to be the most successful in the Fed’s history.

The great recession in 2008 caused by the bursting of the housing market bubble resulted in widespread unemployment and a collapse in the value of mortgage-backed securities (MBS). Banks became risk-averse and opted to hoard cash instead of lending it, resulting in a choked-off economic credit flow.

The Fed exhausted all its conventional monetary policy tools, lowering the Fed funds rate to nearly zero, but the economy was still contracting. Then Fed chairman Ben Bernanke initiated the first QE program, which included purchasing $200 billion in agency debt, $1.25 trillion in mortgage-backed securities, and $300 billion in long-term Treasury debt.

The Fed’s quantitative easing injected a total of $1.75 trillion into the financial market between 2008 and 2009, effectively increasing the money supply and reducing interest rates. However, there are many debates as to whether the Fed’s quantitative easing achieved its purpose.

Quantitative easing (QE) is a monetary policy tool central banks use to stimulate the economy by increasing money supply, lowering long-term interest rates, combating deflation, and stimulating borrowing and lending for investments. QE ensures that the economy experiences a ‘soft landing’ as it recovers from economic stress or recession.

Central banks increase the money supply in the economy when they purchase bonds or other assets, making more funds available for banks to lend to businesses and consumers.

Quantitative easing increases the prices of long-term securities such as government bonds and lowers their yields (interest rates). Lower yields make borrowing cheaper for businesses, allowing them to invest in other assets like stocks and enabling consumers to spend more.

Quantitative easing minimizes the risk of price deflation because consumer spending and investor appetite are high.

No, quantitative easing isn’t the same as quantitative tightening (QT). Quantitative easing involves central banks buying government bonds and other assets to increase the money supply and lower interest rates, while quantitative tightening involves central banks selling the bonds and assets they hold on their balance sheets to reduce the money supply and raise interest rates.

The goal of QE is to stimulate a contracting or stagnant economy, while QT aims to slow down economic growth in an overheated economy. This “quantitative tightening definition” means that QE and QT are opposite monetary policy tools central banks use to achieve different economic goals.

The central bank’s role in employing Quantitative Easing involves implementing and overseeing the purchase of selected financial assets, like government bonds or MBS, from commercial banks and financial institutions to increase money supply in the market, lower interest rates, and encourage lending and spending.

Central banks monitor the impact of the QE programs on the economy using indicators like money supply changes, interest rate movements, inflation, and employment levels. The central bank role allows them to adjust the QE program’s size, duration, or scope to ensure it achieves the desired economic objective.

Quantitative easing is important because it enables central banks to address major economic challenges like recessions or low inflation, where traditional monetary policy tools like lowering interest rates are ineffective. QE injects the liquidity needed in the economy, stimulating economic growth and enabling central banks to achieve their inflation targets.

QE’s importance in tackling recessions relies on lowering long-term interest rates and making mortgages, business loans, and car loans cheaper for consumers. Lower interest rates encourage people to spend more and allow businesses to hire more staff or diversify their investments, leading to higher economic growth.

QE prevents deflation by introducing new money into circulation when central banks purchase bonds and other securities. QE programs stimulate demand for different goods and services as consumers spend money, cushioning prices from further declines.

QE ensures that more money is targeted or distributed to specific sectors of the economy that need the most help. For example, during the Great Recession, the Fed pumped billions into purchasing mortgage-backed securities (MBS), which helped make housing affordable.

Quantitative easing helps restore investor confidence by signaling that the central bank is committed to supporting the economy. The increased confidence created by quantitative easing measures pushes investors to increase their investments in the country, leading to economic growth.

Quantitative easing works by purchasing large amounts of financial assets, including government bonds, mortgage-backed securities, treasury bills, corporate bonds, and other long-term securities. Central banks like the Fed, the European Central Bank (ECB), or the Bank of England (BoE) buy these assets and print new money, which is added to the financial reserves of commercial banks.

Central banks keep buying bonds and other assets depending on the market landscape, resulting in higher demand for bonds and reducing their yields (interest rates), making it cheaper to borrow money.

Central banks hope that the banks or financial institutions that receive the financing lend the newly received funds to businesses and individuals at low interest rates so they are able invest it in other ventures like stocks or real estate to drive up their prices.

Carbon quantitative easing (CQE) is a proposed monetary policy that advocates for big central banks to collaborate to create a new digital global currency that funds green investments. CQE aims to encourage countries to shift away from fossil fuels to cleaner energy sources to tackle climate change.

Quantitative easing ensures money circulates from the government reserves to a consumer’s wallet, boosting economic activity.

The role of quantitative easing in the forex market involves increasing the supply of currencies for devaluations, attracting capital inflows, and influencing market volatility. When central banks purchase financial assets to inject liquidity into the market, they increase the supply of the currency, resulting in a weaker currency relative to others.

Quantitative easing increases trading opportunities in the market by allowing traders to profit from short-selling the weakening currency and going long on currencies expected to strengthen against it.

QE tends to lower interest rates, reducing the attractiveness of some currencies to investors and increasing the demand for strong currencies in the forex exchange market. Investors and traders facilitate this dynamic by moving their money from low-yield investments to high-yielding currencies.

Quantitative easing increases the volatility of some currency pairs when their central banks implement divergent monetary policies.

Traders and investors use quantitative easing to determine high-potential assets to purchase and the best times to open positions.

Central banks use quantitative easing to stimulate the economy during periods of low growth and deflation. QE is a complex tool that only central banks control directly and use to achieve their objectives, like the Fed and BOE’s 2% inflation target. There are six steps to using quantitative easing.

First, central banks assess economic conditions using indicators such as inflation, GDP growth, unemployment, and others to determine the need and appropriateness of QE.

Secondly, central banks design the QE program, setting clear objectives and selecting the target asset classes to purchase, typically government bonds and mortgage-backed securities.

Thirdly, the central bank implements the quantitative easing (QE) program by purchasing assets on the open market from banks and institutions. The purchases of assets on the open markets inject new money into the economy, increasing bank reserves and lowering long-term interest rates.

Fourth, the central bank chairperson announces the QE program, detailing asset purchases’ scale, scope, and duration to manage market expectations and enhance the program’s effectiveness.

Fifth, the central bank monitors the impact of QE on the economy, making the necessary adjustments (e.g., increasing or decreasing asset purchases) to ensure the program meets its objectives. Central banks track changes in money supply, GDP growth, interest rate movements, and other indicators to achieve this.

Finally, the central bank implements exit strategies, gradually reducing the pace of asset purchases and normalizing interest rates from zero as the economy recovers.

The steps to use Quantitative Easing in Forex trading are listed below.

1. Understand the Purpose: Before incorporating Quantitative Easing (QE) into your Forex trading strategy, comprehend its purpose and impact on currency pairs.
2. Monitor Central Bank Announcements: Stay informed about announcements and statements from central banks regarding QE initiatives.
3. Analyze market reactions: Observe how markets react to QE program announcements and how previous QE programs affect currency values over time.
4. Develop trading strategies: Use technical analysis to identify key levels and look to short-sell the country’s currency implementing QE; for instance, open sell positions on EUR/USD if the ECB is implementing QE and the Fed isn’t.
5. Implement risk management: Use stop-loss orders to manage risk and adjust the position size based on the increased risk and volatility.
6. Monitor and adjust strategies: Be prepared to adjust your forex (FX) trading strategy as new information becomes available or as market conditions change.

Forex traders utilize quantitative easing to understand how central banks manage currency valuations in different market conditions and develop strategic trading positions. The traders analyze the historical impact of Federal Reserve quantitative easing programs to understand how markets reacted in similar situations.

Experienced forex currency traders leverage the increased money supply and market liquidity to take carry trades and exploit other trade opportunities as the markets stabilize.

Traders consider quantitative easing announcements opportunities to diversify their portfolios to multiple currencies by projecting the impact of QE on specific currencies and their cross-pairs. Diversifying their portfolios helps traders manage risk when trading.

Central banks use quantitative easing when the economy is in recession, interest rates are near zero, or inflation is below their target.

Central banks implement QE when there’s a liquidity crisis, and people prefer to hold on to cash rather than invest or spend it.

QE stimulates the economy when the GDP is negative or very low and there’s limited economic activity. QE programs increase the money supply during recessions to encourage bank lending and consumer spending.

Central banks’ use of QE relies on other conventional monetary policies failing when interest rates drop to almost zero with minimal effectiveness.

Central banks use quantitative easing when inflation is low, and prices are declining sharply to stimulate spending and investment, allowing them to prevent deflation and achieve their inflation target.

The quantitative easing examples are listed below.

• United States Federal Reserve (November 2008 – March 2010): To stabilize the failing financial system and the collapsed housing market, the U.S. Fed purchased $1.25 trillion in Mortgage-Backed Securities, $200 billion in agency debt, and $300 billion in long-term Treasury securities.
• Bank of Japan (October 2010 – April 2013): To address deflation and boost economic growth, Japan’s BoJ purchased a total of ¥43 trillion in assets, including Japanese government bonds (JGBs), Tokyo-listed ETFs, REITs, corporate bonds, and commercial paper.
• Bank of England (March 2009 – February 2012): To support economic growth after the financial crisis of 2008, England’s BoE purchased a total of £200 billion in assets, primarily government bonds (gilts).
• Eurozone (European Central Bank) (March 2020 – March 2022): In response to the economic impact of the COVID-19 pandemic, the Eurozone’s ECB purchased a total of €1.85 trillion in government and private sector securities, such as corporate bonds, asset-backed securities, covered bonds, and commercial paper.

The benefits of quantitative easing are listed below.

• Stimulating economic growth: QE increases the money supply and encourages spending and investment, increasing economic activity.
• Lowering interest rates: QE increases the demand for long-term securities, lowering interest rates and making borrowing more affordable to businesses and consumers.
• Addressing deflationary pressures: QE increases inflation expectations, helping push prices upward and facilitating price stability.
• Supporting financial markets: QE provides liquidity to financial institutions like banks, ensuring they have enough capital to withstand challenging economic conditions and restoring confidence among banks.
• Enhancing credit availability: QE increases commercial bank reserves, allowing them to lend to businesses that reinvest in their companies, leading to higher employment and real wage growth.

The limitations of quantitative easing are listed below.

• Potential inflationary pressures: QE can increase inflation when central banks inject too much money into the economy, causing prices to rise and eroding purchasing power.
• Market distortions: QE can create asset bubbles by artificially inflating their prices, leading to misallocation of resources.
• Dependency on central bank intervention: QE can lead to economic imbalances due to the over-reliance on monetary policy to stimulate the economy over other fiscal policies.
• Income and wealth inequality: QE primarily benefits wealthy individuals who already own financial assets since asset price increases boost their portfolio value, while lower borrowing costs benefit corporations more readily than individuals or small businesses.
• Normalization challenges: Exiting a QE program can be difficult because removing market liquidity too fast may stall economic growth, and taking too long may cause inflation.

Yes, quantitative easing decreases a country’s exchange rate due to the increased money supply, which increases the demand for bonds and other financial securities and lowers interest rates, making the currency less attractive to foreign investors. QE weakens the nation’s currency but increases the prices of bonds, stocks, and other assets due to the increased demand.

A study by Ijiri, Hiroyuki, and Yoichi Matsubayashi (2023), titled “Quantitative Easing Policy, Exchange Rates And Business Activity By Industry In Japan From 2001 To 2006,” found that QE diminished the yen–dollar exchange rate but expanded stock prices throughout its implementation period. QE also stimulated Japan’s production in almost all industries, including the machinery industry, during its final implementation period.

QE affects the “exchange rate definition” for middle-income countries, which use it to weaken their exchange rates, making their exports cheaper and more competitive in global markets, potentially boosting their manufacturing industries. However, weak currencies may increase the country’s import cost.

Yes. QE works under the right market conditions. The Fed, BOE, and ECB considered QE highly successful in the early stages of its implementation during the 2007-2008 financial crisis and 2020’s coronavirus crisis. QE policies generally work by lowering interest rates in the market and driving up prices of other assets like stocks.

According to Gagnon, J., et al. (2010) in the paper ‘Large-Scale Purchases by the Federal Reserve: Did they work?’ QE is an effective way to lower long-term borrowing rates and stimulate the economy. Gagnon noted that the effect of the Fed using QE in 2008 was most noticeable in the mortgage market and spread across markets, including Treasury bills, corporate bonds, and interest-rate swaps.

Many economists, however, express concerns with implementing QE programs since it’s hard to quantify their impact on the markets. A big case against QE programs is that they exacerbate income inequality, favoring the wealthy and asset-rich individuals over low-income earners.

Research by Saiki, Ayako, and Jon Frost. (2014) titled “Does unconventional monetary policy affect inequality? Evidence from Japan’ found that Japan’s QE program led to a disproportionate rise in asset prices compared to economic fundamentals (notably wages and employment). The higher asset prices primarily benefit the higher-income households, allowing them to generate greater capital income while expanding the wealth gap in the country.

Overall, quantitative easing has clear advantages and disadvantages, as Stephen Williamson, a former economist with the Federal Reserve Bank of St. Louis, concluded.

The difference between quantitative easing and credit easing (CE) lies in their focus and method of operation. Quantitative easing is a central bank policy that involves purchasing long-term securities like government bonds to stimulate the economy by increasing the money supply. Credit easing is a central bank policy that involves purchasing specific private sector assets, like corporate bonds, to kick-start and stabilize the credit market.

Both quantitative easing and credit easing stimulate economic growth and facilitate financial stability in the markets, but QE focuses on broad-based liquidity injections and interest rate effects, while CE targets the banking system to improve credit availability.