Quantitative easing (QE) is a monetary policy tool used by central banks to stimulate the economy. It involves expanding the money supply by purchasing government bonds, corporate bonds, and other financial assets from the open market.
Central banks use QE to encourage lenders to increase lending and investment in order to boost overall economic activity.
The United States Federal Reserve has used QE several times since the financial crisis in 2008.
How Quantitative Easing works
When interest rates are close to zero and economic growth slows, central banks may opt to implement a policy called quantitative easing. This approach is employed because central banks have limited tools available, such as rate reduction, with which to influence aggregate economic growth.
In order to stimulate borrowing and consumption, central banks increase the supply of money through the purchasing of government bonds and other securities. These actions lower interest rates below what would have been the case if the policy had not been enacted and provide additional liquidity to the banking sector so that lending conditions become easier for consumers.
During the COVID-19 pandemic, governments have had to rely on both monetary and fiscal policy in order to expand their money supply. Quantitative easing is a tool that combines both policies, with the Federal Reserve influencing the supply of money while the Treasury Department creates new money and implements new tax regulations.
This was evidenced during the first quarter of 2021 when 56% of total securities issuance was backed by the Federal Reserve in the United States of America.
This mix of policies meant that Governments were better positioned to support individuals, businesses, and the economy as a whole throughout this difficult period.
Benefits of Quantitative Easing
- QE helps to lower long-term interest rates, which encourages businesses and consumers to borrow money and invest in projects that spur growth.
- QE increases the supply of credit, making it easier for businesses to obtain financing for investments.
- QE boosts asset prices, including stocks and bonds, which increases wealth and consumer spending power, further spurring economic activity.
- QE helps stabilize markets during periods of financial distress by providing liquidity and reducing volatility.
Risks of Quantitative Easing
Japan’s economy fell into a recession in 1997, initiated by the Asian financial crisis. To battle, this recession and inflation, the Bank of Japan implemented a daring quantitative easing program that included purchasing private stocks and debt rather than merely government bonds. Despite their intentions, this program was not successful, and Japan’s GDP decreased significantly from $5.45 trillion in 1997 to $4.52 trillion three years later. This illustrates the failure of large-scale quantitative easing to return a nation’s economic health to its previous levels.
The risks include:
As more money is injected into an economy, a central bank must remain alert to the potential risk of inflation. Generally, it takes around 12 to 18 months for an increase in the money supply to start affecting price levels – any earlier than that and there could be an issue. If stimulus attempts are successful in the short term but fail to generate sufficient economic growth long-term, it can lead to stagflation – where prices continue to rise while unemployment remains high. In this case, central banks must remain proactive in order to keep such negative externalities under control.
In periods of increasing liquidity, the ability of a central bank, such as the Federal Reserve, to influence lending activity is limited. Banks have no obligation to lend despite a favorable interest rate environment and businesses may be unwilling to borrow due to market uncertainty. As a result, cash is held at banks instead of being loaned out or alternatively companies hold onto their reserves in order to preserve short-term financial stability.
This phenomenon is referred to as a “credit crunch”, where reduced lending and monetary transactions are observed despite increased money supply due to higher amounts of available liquidity.
When the money supply increases due to this sort of policy, it is usually associated with currency devaluation in the domestic market. While a weakened local currency can help exporters, as their goods become cheaper in the global market, imports may become more expensive as the buying power of foreign currency increases relative to the local currency. This drives up consumer prices and costs of production, thus counterbalancing any potential benefits from cheaper exporting. Thus, quantitative easing needs to be comprehensively structured and carefully considered before implementation if its desired effects are to be achieved.
Is Quantitative easing printing money?
Quantitative easing, a form of monetary policy first developed in 1991 by the Bank of Japan, has been the subject of much debate among economists.
Critics have argued that it could lead to hyperinflation if used recklessly – a valid concern, as money printing used off-handedly has caused considerable damage in some countries.
Proponents maintain that this fear is largely unfounded; quantitative easing works primarily by allowing banks to expand their balance sheets in order to lend more freely and stimulate economic growth, and since cash is not distributed directly into the hands of individuals or businesses there is less risk of inflation spiraling uncontrollably.
Impact of Quantitative Easing on the crypto industry
Bitcoin emerged out of the financial crisis in 2008-2009 as a response to quantitative easing. Its foundational architecture provided an alternative to standard fiat currencies, allowing for verifiable soundness and stability untainted by manipulation or favoritism. It was Bitcoin’s decentralized nature which enabled its rapid adoption within the crypto space and allowed it to rapidly become the “All-father” of cryptocurrency. The effects of the QE policies responsible for its genesis remain unknown, but shed light on the potential effects of quantitative easing on cryptocurrency.\
As the global markets remain in an uncertain state due to monetary policies, investors are looking towards alternative measures to diversify their portfolios. One such option is cryptocurrencies, which have seen a sharp increase in adoption since 2021.
In light of quantitative easing (QE), there is an expectation that will provide further motivation for hedge funds and higher net-worth investors to enter the crypto space. This will bring more capital and liquidity into the crypto market, making it an attractive option for risk-averse investors looking for a return on investment or simply to protect their assets from inflation.
Crypto functions much like digital gold in providing a strong unit of account and medium of exchange with a great level of fungibility. It is quickly gaining popularity as an ideal store of wealth in less favorable economic climates. Although some assume that quantitative easing causes a surge in crypto prices, there appears to be little evidence to support this claim.
Quantitative easing is a powerful tool for stimulating economic growth, but its effects can be unpredictable. As with any other policy, it should only be used when necessary and with caution. It also has ramifications in the crypto industry as investors seek alternative stores of wealth. While quantitative easing may not have an obvious effect on crypto prices, it is clear that the increased liquidity and capital brought about by QE policies could lead to greater adoption of cryptocurrencies. Ultimately, only time will tell the full extent of quantitative easing’s influence on the cryptocurrency markets.
Therefore, it is important to stay informed and make decisions based on the most current market conditions.