Quantitative easing: What is it?

Quantitative easing has been used before by some central banks around the world to try and spark recovery in struggling economies. With low inflation and sluggish wage growth, could Australia’s central bank soon do the same?

Alongside the ability to change the cash rate, the Reserve Bank of Australia (RBA) also has the power to use a policy called quantitative easing to assist Australia’s economy. But what is it?

What is quantitative easing or QE?

Put simply, quantitative easing (QE) is a type of unconventional monetary policy whereby central banks increase the supply of money to the economy to try to boost inflation and avoid recession. They typically don’t do it by literally printing extra money though, as is a common assumption.

Quantitative easing explained - not printing money
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Most central banks instead use their cash reserves to buy government bonds or other financial assets, which starts the process of stimulating a spending cycle. It’s like a central bank taking money from its own wallet and buying something from the government or a regular bank. The seller then has more cash to give to people – perhaps in the form of tax cuts, in the government’s case, or loans if it’s a bank. The idea is that people who get that tax cut or loan will spend the money – perhaps buying a house or car or starting a business – which helps the economy to grow.

There’s another way that QE could help get the economy moving again – it typically contributes to lower interest rates, too. When banks have more funds available to finance more loans, people can potentially find it easier to shop around to find the best deal. Competition is increased, and interest rates start to go down. Lower interest rates are meant to encourage more spending, which results in increased demand for goods and services, makes more jobs and ultimately stimulates the economy… in theory.

The effectiveness of QE as a monetary policy tool is commonly debated. The Bank of Japan has used it over the past few decades in an effort to revive Japan’s deflated economy, but critics say it has ultimately failed to create real growth – the country now has negative interest rates. Starting in late 2008, the United States’ Federal Reserve also used QE to try to bail the country out of the Global Financial Crisis, while the Bank of England and European Central Bank have also used QE in various forms over the past decade or so.

Will Australia use quantitative easing to help stimulate our economy?

Previously, economists and financial experts were divided over whether the RBA should use QE now that the cash rate is so low. The strategy is generally used when interest rates approach zero, at which point central banks have few options left to influence economic growth.

However, on 16 March RBA Governor Philip Lowe announced the central bank was ready to use QE to assist Australia’s economy amidst the pressure brought about by coronavirus.

“As Australia’s financial system adjusts to the coronavirus (COVID-19), financial regulators and the Australian Government are working closely together to help ensure that Australia’s financial markets continue to operate effectively and that credit is available to households and businesses,” Dr Lowe said in a statement.

“Australia’s financial system is resilient and it is well placed to deal with the effects of the coronavirus. At the same time, trading liquidity has deteriorated in some markets.

“In response, the Reserve Bank stands ready to purchase Australian government bonds in the secondary market to support the smooth functioning of that market, which is a key pricing benchmark for the Australian financial system.”

This will be the first time QE has been used in Australia.

The statement also said the RBA would conduct “repo operations” whereby the bonds it buys will be sold to investors before being repurchased for a slightly higher price.

Is quantitative easing the same as ‘helicopter money’?

While they are related forms of monetary policy aimed at growing the economy, helicopter money and quantitative easing are quite different. Helicopter money is a strategy that involves a central bank attempting to increase consumer spending by supplying large amounts of newly “printed money” to the public, as if the money was being dropped from a helicopter – hence the term “helicopter money”.

Quantitative easing vs helicopter money
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By comparison, QE does not make cash directly available to consumers. It gives banks the boost, or the government in the form of buying government bonds. Another major difference between QE and helicopter money is that with the latter, there is no asset being purchased by the central bank that it can later sell to re-tighten things again, meaning helicopter money is generally less reversible than QE.

Helicopter money, if used in Australia, would most likely involve the RBA financing government expenditure – such as tax cuts or “gifts” to households – and money would be added to bank accounts (physical banknotes wouldn’t actually be printed). The money the RBA would give to the government would be interest-free and the government wouldn’t have to pay back the debt to the central bank.

While helicopter money might increase consumer consumption, it’s generally seen as a “last resort” strategy because it could lead to currency devaluation due to the creation of more money, hyperinflation or irresponsible government spending. On the flip side, a possible advantage of helicopter money is that since it is effectively ‘free money’ for consumers and doesn’t have any interest attached, it’s more likely to have a quick impact on consumer spending, as argued by some economists.

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