Although “quantitative easing” sounds complex, the idea is relatively simple in economic terms. The central banking system, the Federal Reserve in America, buys bonds from private or commercial banks. As the Wall Street Journal explains, “Bonds are a form of debt. Bonds are loans, or IOUs, but you serve as the bank. You loan your money to a company, a city, the government – and they promise to pay you back in full, with regular interest payments. A city may sell bonds to raise money to build a bridge, while the federal government issues bonds to finance its spiraling debts.”
Now, with quantitative easing, the Federal Reserve buys bonds at a slightly higher price than anyone else in the market is willing to pay. This injects cash into the market and creates economic growth. Businesses can borrow money more easily. Spending power increases through bank loans to businesses and individuals. This can turn around an economy in the throes of a recession.
Here’s the rub. The Federal Reserve pays for the bonds by inventing new money electronically and paying for the securities with this new money. This influx of cash is supposed to stimulate the economy. However, many argue that quantitative easing only compounds economic problems by triggering a dangerous inflationary spiral. Nonetheless, citing necessity during a past implementation of quantitative easing, the Financial Times stated, “The Federal Reserve, the Bank of England and the European Central Bank each had to intervene in order to prevent a deeper economic depression.” Because the market already had such low interest rates, the only way they could intervene was by quantitative easing.
As Kimberly Amadeo explains in the balance: make money personal, during the Great Recession that began in around 2007, Quantitative Easing “removed toxic subprime mortgages from banks’ balance sheets, restoring trust and therefore banking operations. Second, it helped to stabilize the U.S. economy, providing the funds and the confidence to pull out of the recession. Third, it kept interest rates low enough to revive the housing market.” One has to wonder, though, how long the American economy can endure inflationary spirals and the ongoing damage to the U.S. dollar things like quantitative easing bring. After all, inflation is a hidden tax on every American.
The video below, featuring Paddy Hirsch, a senior editor at www.marketplace.org, explains quantitative easing in further detail.
