Quantitative Easing Explained: How Central Banks Print Money

What is Quantitative Easing?

Quantitative easing, or simply QE, is a central bank’s way to prop up an economy during a downturn. Central bankers do this by purchasing assets in the debt and equity capital markets in an attempt to lower interest rates. This sets off a domino effect in the economy. At first, QE feels good all around. But the hangover sets in the next morning. 

A central bank’s buying bolsters the amount of money circulating in the economy, which, in turn, pressures interest rates lower, ultimately sparking lending activity to individuals and businesses. It is a way to artificially support the economy in the short term but eventually the time will come to pay the piper. 

Quantitative easing was drummed up by German Economist Richard Werner in the mid-1990s. Japan’s quantitative easing program was the first use case of this strategy during the Asian Financial Crisis in 1997. 

In the U.S., Ben Bernanke is the grandfather of QE. The former Federal Reserve Chairman implemented quantitative easing during the Great Financial Crisis of 2008. 

On Bernanke’s watch, the Fed printed money out of thin air and directed it toward buying bonds, commercial paper, and mortgage securities, perpetuating a cycle in which the money supply increased even more. Some blame Bernanke for the massive inflation that the economy is experiencing today. 

It was under Bernanke’s expansive monetary policy that U.S. banking reserves ballooned from $870 billion prior to the GCF to $2.1 trillion. According to Bernanke, “The problem with QE  is that it works in practice but it doesn’t work in theory.” 

The Bank of England’s asset purchase facility (APF) balance sheet has similarly been expanding since 2009.

Effects of Quantitative Easing

Quantitative easing is not all bad. There are some positive effects of this type of monetary easing. For example, macroeconomist and former Fed Governor Jeremy Stein once praised QE including large-scale asset purchases for playing a “significant role in supporting economic activity.” However, it is important to note that research from central banks have a tendency to be biased.

Other research has shown that QE in the U.S. economy after the GFC resulted in persistently lower interest rates on a number of assets and less credit risk. This dynamic resulted in stronger economic expansion but also inflation. Money flowed into equities and bolstered their valuations, ultimately widening the divide between high-net-worth individuals and the working class. 

QE is also credited with having to help prevent a deflationary economy in the eurozone from 2013-2014 and blocking the steepening of bond yields among EU countries. The Bank of Japan’s historic QE is said to have strengthened stock prices but did little to ignite corporate investment.  

However, what goes up must come down. There are serious risks associated with QE, not least of which is high inflation. When the central bank turns the money printer to the “on” position, it inflates the dollar (or other fiat money) supply in the economy. 

As a result, demand increases while the buying power of the dollar in circulation weakens, sending prices skyrocketing. QE could also have the intended consequence of acting as a steroid in the stock market, creating bubble-like conditions in equity valuations as well as in the real estate market. Investors lose their fear of risk and expect that the central bank will rescue them. According to investment bank UBS, in the 10 years leading up to 2019, returns on assets were highly correlated with the Fed’s QE programs. 

The Fed is raising rates faster than any other time in modern history 👀 pic.twitter.com/Cq21nzTSCn

— Bullish Rippers (@BullishRippers) December 16, 2022

Quantitative Easing Explained with Examples

• Quantitative easing was popular during the COVID-19 pandemic among central banks globally. Central banks across the U.S, Japan, the U.K., and the eurozone purchased approximately $10.2 trillion in securities assets, resulting in total assets on their balance sheets expanding to more than $25.9 trillion. According to the United Nations, these QE programs delivered “market liquidity” and an easing of “financial conditions in times of severe financial distress and market dysfunction.” In the U.S. this was followed up by a year of aggressive quantitative tightening in 2020 to combat the soaring inflation that was a consequence of its QE during the health crisis. 
• On the heels of the Great Financial Crisis, the U.S. Fed implemented a QE program that lasted from 2009-2014. During this time, the Fed purchased assets like bonds and mortgages, resulting in its bank reserves surpassing $4 trillion by 2017. 
• After Japan suffered a major financial crisis in the late 1990s, the country implemented QE in the economy to fight deflation and jumpstart the economy. The Bank of Japan purchased stocks, bonds, and private debt. However, its attempts were futile and GDP wound up plummeting from $5.45 trillion to $4.52 trillion. 

Below is an illustration of the ECB’s balance sheet and a forecast of the results of its quantitative tightening, as provided on Twitter by Philipp Heimberger, economist at the Vienna Institute for International Economic Studies. The original source of the image was Pictet WM CIO Office & Macro Research. 

Quantitative Easing (QE) vs Quantitative Tightening (QT)

We know that QE is the practice of a central bank buying up securities in the open market. When a central bank is easing, the cycle goes as such:

• Long-term interest rates should fall
• More money is added to supply to make asset purchases 
• Lenders should extend the liquidity they are receiving to consumers and businesses to stimulate the economy

On the other hand, quantitative tightening, or QT, is the opposite behavior and involves a government selling assets into the market. By unloading assets it has on its balance sheet, the central bank is slashing the fiat money supply in circulation. Put another way, QT is removing money from the financial system, resulting in higher borrowing costs to individuals and businesses alike.

David Marlin of Marlin Capital suggests that the Fed has a way of underestimating the “eventual pain monetary tightening brings to the labor market.” He demonstrates this with a chart that shows the change in the employment rate expressed as in percentage points during recessions.

The Fed always underestimates the eventual pain monetary tightening brings to the labor market. $SPY $QQQ $AAPL $TSLA $META $NVDA pic.twitter.com/DrDFyXPewi

— David Marlin (@Marlin_Capital) December 17, 2022

The Federal Reserve Bank of Atlanta’s Bin Wei likens QT with interest rate hikes, stating:

“[A] $2.2 trillion passive roll-off of nominal Treasury securities from the Federal Reserve’s balance sheet over three years is equivalent to an increase of 29 basis points in the current federal funds rate at normal times, but 74 basis points during turbulent periods.” 

Ultimately QE and QT are tools used by global central banks in an attempt to keep prices stable and inflation low as well as to handle any severe swings in the economic pendulum that may come their way.