Explain what is meant by quantitative easing (QE) and consider whether it is an effective
policy to be used in a recession. [12]
Quantitative Easing is an unconventional monetary policy which which the central banks uses
electronically created money to purchase nancial assets, usually bonds, from nancial institutions
such as commercial banks. By this, banks will have an improved liquidity ratio and will be
incentivised to give out loans. Lower yields on bonds indicates lower interest rates that would
improve consumption and investment in an economy. With the rise in bond prices, there is likely to
be a positive wealth effect. Further, lower interest rates will cause a currency to depreciate, likely
boosting exports. This mechanism is likely to boost aggregate demand within an economy and help
aid it out of a recession.
Quantitative Easing was rst used in Japan in the 90s, but became popular following the Global
Financial Crisis in 2008 when the Bank of England adopted the policy. It was introduced due to a
liquidity trap. A liquidity trap, by Keynesian theory, is when interest rates cannot be reduced any
further to stimulate aggregate demand in an economy. Due to the hindering of the primary monetary
policy, QE was adopted.
Whilst there is a general consensus that QE contributed to minimising the recessions following ‘08,
it came with several risks. Firstly, digitally created money, like printing money, has the potential to
create in ationary pressure within an economy. As monetarists claim, the money supply should not
increase more than real GDP or else in ation will occur. However, this was largely not considered a
concern for governments as the main goal was to prevent de ation. Further, there is possibility of a
credit crunch, where liquidity is held by banks instead of being loaned out due to uncertain business
climates. Lastly, whilst a depreciation can boost exports and overall AD, there is a chance that with
relatively more expensive imports, costs of production could rise creating cost-push in ation. Yet,
going back to the rst point, this is not the main concern for governments adopting QE.
In real life scenarios, QE and its effectiveness can be observed in terms of its ability to ease a
recession. First, Japan adopted a rather aggressive QE strategy that extended to purchasing private
debt and stocks, not just government bonds, however its GDP still fell by approximately $1 trillion.
Switzerland also adopted QE during the GFC and whilst economic growth did increase, it is unsure
howe much of he recovery can be attributed to QE.
In conclusion, QE is an unconventional monetary policy adopted when interest rates are
approaching a potential liquidity trap. By increasing the liquidity of nancial institutions and
lowering credit, aggregate demand is thought to increase, limiting a recession. QE has been adopted
by many governments including Japan, Switzerland, and Britain and whilst it has theoretic validity,
there is still debate as to the extent of its effectiveness.
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policy to be used in a recession. [12]
Quantitative Easing is an unconventional monetary policy which which the central banks uses
electronically created money to purchase nancial assets, usually bonds, from nancial institutions
such as commercial banks. By this, banks will have an improved liquidity ratio and will be
incentivised to give out loans. Lower yields on bonds indicates lower interest rates that would
improve consumption and investment in an economy. With the rise in bond prices, there is likely to
be a positive wealth effect. Further, lower interest rates will cause a currency to depreciate, likely
boosting exports. This mechanism is likely to boost aggregate demand within an economy and help
aid it out of a recession.
Quantitative Easing was rst used in Japan in the 90s, but became popular following the Global
Financial Crisis in 2008 when the Bank of England adopted the policy. It was introduced due to a
liquidity trap. A liquidity trap, by Keynesian theory, is when interest rates cannot be reduced any
further to stimulate aggregate demand in an economy. Due to the hindering of the primary monetary
policy, QE was adopted.
Whilst there is a general consensus that QE contributed to minimising the recessions following ‘08,
it came with several risks. Firstly, digitally created money, like printing money, has the potential to
create in ationary pressure within an economy. As monetarists claim, the money supply should not
increase more than real GDP or else in ation will occur. However, this was largely not considered a
concern for governments as the main goal was to prevent de ation. Further, there is possibility of a
credit crunch, where liquidity is held by banks instead of being loaned out due to uncertain business
climates. Lastly, whilst a depreciation can boost exports and overall AD, there is a chance that with
relatively more expensive imports, costs of production could rise creating cost-push in ation. Yet,
going back to the rst point, this is not the main concern for governments adopting QE.
In real life scenarios, QE and its effectiveness can be observed in terms of its ability to ease a
recession. First, Japan adopted a rather aggressive QE strategy that extended to purchasing private
debt and stocks, not just government bonds, however its GDP still fell by approximately $1 trillion.
Switzerland also adopted QE during the GFC and whilst economic growth did increase, it is unsure
howe much of he recovery can be attributed to QE.
In conclusion, QE is an unconventional monetary policy adopted when interest rates are
approaching a potential liquidity trap. By increasing the liquidity of nancial institutions and
lowering credit, aggregate demand is thought to increase, limiting a recession. QE has been adopted
by many governments including Japan, Switzerland, and Britain and whilst it has theoretic validity,
there is still debate as to the extent of its effectiveness.
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