Quantitative easing or QE, is an occasionally used monetary policy, which is adopted by the Central Bank to increase money supply in the economy in order to further increase lending by commercial banks. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. In this way, commercial banks and finance companies have new capital to fund mortgages and loans for business and households. The QE is equivalent to print new banknotes.

Central Bank and QE. Its Effects on the Economy

Central Banks normally set the price of money using official interest rates to regulate the economy. They affect the cost of loans paid by companies, the cost of mortgages for households and the return on saving money. Then, one of the main tools that a Central Bank often uses when its economy is in trouble, is the lowering of interest rates. But only this monetary policy tool is not adequate to revive the economy of a country and there is another way of affecting the price of money: Quantitative Easing (QE). The Central Bank infuses a pre-determined quantity of money into the economy by buying financial assets from commercial banks and private entities. This leads to an increase in banks' reserves (as shown in Tab.1).

Tab. 1: Quantitative Easing

The Central Bank therefore, can reduce the phenomenon of the credit crunch, saving banks, eliminate from their budgets the "toxic assets" and buy government bonds with the aim to reduce the public debt.

In this way, the main effects of QE on the economy are the increase in economic activity promoted by the better circulation of money; lowering the cost of loans due to the purchase of government bonds by the Central Bank which increases demand and, at the same time, it reduces costs.

Fed, Bank of England, Bank of Japan, ECB. Different methods of monetary policy

After the economic crisis of 2007, the major central banks have adopted different methods of monetary policy and QE. Especially, the Federal Reserve (FED), the Bank of England (BOE) and the Japanese Central Bank (BOJ) have injected trillions of dollars into the world economy, in order to revive their economy (as shown in Table 2).

Table 2: QE policies adopted by FED, BOE and BOJ 2001-2014

In the United States, England and Japan, the central banks have used the QE to create new money and injecting it in their financial and economic system, with open market operations.

In the U.S., the economic and financial crisis of 2007 was faced with a very expansive approach with a strategy known as Credit Easing (CE). For the lack of liquidity which immediately hit the United States, the FED has lowered the federal funds rate from 2% to 1, 5% and then further reduced to 1% to 0-0.25% (as shown in Table 3).

Table 3: Performance on the Fed funds target

Source: FED

Subsequently, the FED has stimulated the economy with three floors of QE (QE1, QE2 and QE3). The newest form of this expansion (QE3) consisted in the purchase of public debt and Mortgage Backed Securities (MBS) by the Central Bank. This approach has been followed by the Bank of England (BOE) and a few years later by the Japanese central bank (BOJ) through monetary policy also known as Abenomics. In contrast, the European Central Bank (ECB) has adopted a less expansionary monetary policy despite the conditions of risk and illiquidity in the interbank markets in Europe were similar to those of the United States and other countries. In Europe, the ECB, could not adopt QE such an instrument of monetary policy for the restrictions of his mandate.

The ECB, in fact, in order to achieve its basic goal (price stability and inflation rate not exceeding 2%), initially decided not to use QE operations. It is limited to small Bond purchases through liquidity auctions and not through the issuance of new currency (in December of 2011, the ECB has carried out two operations of Long Term Refinancing - LTRO). In 2011, in fact, the ECB has bought 10 billion of bank bonds and 200 billion public debt of Greece, Portugal, Ireland, Spain and Italy. But the overall quantity of these purchased was quite small compared to QE announced in April 2014. In addition to a possible European QE, the ECB has launched two new major refinancing operations (LTRO) to banks for granting loans to households and enterprises (with the exception of loans for house purchase). The original amount for these actions will be approximately EUR 400 billion.

At the last meeting of June 5, 2014, in pursuing its price stability mandate, the Governing Council of the ECB has announced measures to enhance the functioning of the monetary policy transmission mechanism by supporting lending to the real economy. In particular, the Governing Council has decided:

1.       To conduct a series of targeted longer-term refinancing operations (TLTROs) aimed at improving bank lending to the euro area non-financial private sector, excluding loans to households for house purchase, over a window of two years.

2.       To intensify preparatory work related to outright purchases of asset-backed securities (ABS).



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Editor: Giovanni AVERSA