Quantitative Easing can help to Reflate our EconomiesIntroduction Quantitative easing (QE) is an unconventional means of stimulating national economies employed by central banks when conventional monetary policies are no longer effective. It is an expansionary monetary policy in which the central bank injects money into national economy through purchasing of public and private financial assets (Blake & Kirsanova, 2011, p. 41). Central banks often achieve this through the use of open market operations and standing lending facilities. In the past, central banks have primarily relied on monetary measures that seek to reduce interest rates during periods of recession so as to counter deflation or to raise inflation rates.
However, the recent financial crisis and economic recession has posed unusual challenges to central banks, making the use of conventional policy measures to be ineffective. In several cases, central banks have reduced their lending rates to levels close to zero without realising the intended objectives. This has made it necessary for monetary authorities to use QE to stimulate their national economies and to realise the inflationary objective (Blake & Kirsanova, 2011, p. 41).
In most of the economies where this policy has been employed, the key inflationary objective has been to maintain the inflation rate at a particular set target. According to Hamouda (2009, p. 20) the QE policy was used in Japan in 2001 to counter the effects of a severe depression which had hit the country’s economy for a long time. Though this policy helped Japan to stop inflation from falling down further, various issues made the policy ineffective in raising inflation to the target. However, application of this policy during the recent economic crisis by various nations such as the UK and the US has demonstrated that QE is not only a useful tool in preventing inflation from falling below the target; but it can also help to raise inflation to the target.
This paper seeks to explain how QE can help to counter deflationary forces and to raise the inflation rate to the target. It examines its effectiveness in reflating our economies, drawing examples from cases of the US, the UK and Japan. Using QE to control inflationCentral banks in most cases control inflation by use of use interest rates.
They achieve this by pegging a specific lending rate on loans to financial institutions (Hamouda, 2009, p. 20). The central bank rate (also called bank rate) influences many other rates available to borrowers and savers in financial institutions. This affects the rate of spending by individuals and companies, which in turn affects the rate of inflation. Thus, when inflation rises or is expected to rise beyond the set target, Central banks raise their rates. This affects rates in financial institutions, leading to reduced spending and eventually, reduced inflation.
On the other hand, if inflation falls or is expected to fall below the set target, central banks reduce bank rates, which helps to boost spending and to raise inflation. In some cases, inflation may become very low or it may fall to a point where it is very far below the target. In this case, central banks respond by reducing bank rates. But as the Bank of England (BoE) (2011, p. 10), points out, the interest rate may be reduced up to zero, without realising the objective of raising inflation.
At this point, the central bank can achieve the reflationary objective by increasing the quantity of money circulating in the economy. This can be done through the QE process explained in the Keynesian monetary theory (Hamouda, 2009, p. 20). This model assumes that there is a direct relationship between spending and the prices of various commodities in a national economy. As such, the model suggests that increased spending can lead to a higher inflation rate while reduced spending corresponds to a low rate of inflation (Hamouda, 2009, p.