Quantitative Easing and Unconventional Policy
When the policy rate hits its zero lower bound, a central bank turns to unconventional tools. Quantitative easing is large-scale purchases of longer-term assets that expand the central bank balance sheet, push down long-term rates, and add reserves to the banking system.
Why it matters
With the short rate already at zero, the bank cannot cut further, so it works on the long end directly by buying bonds. More demand for those bonds lifts their price and lowers their yield.
Worked examples
A central bank has already cut its policy rate to zero but the economy is still weak. What can quantitative easing do?
It buys long-term government bonds and other assets, which raises their prices and lowers long-term yields, easing financial conditions even though the short rate cannot fall further. The purchases also swell bank reserves.
Common mistakes
- ✗Quantitative easing is just printing money that directly causes inflation. It swaps new reserves for bonds, and much of those reserves sat idle after 2008, so it did not feed straight into prices.
- ✗Quantitative easing lowers the short-term policy rate. The short rate is already at its floor. Quantitative easing works on long-term rates through asset purchases.
Revision bullets
- •A tool for the zero lower bound
- •Large-scale purchases of long-term assets
- •Lowers long rates and expands the balance sheet
Quick check
Quantitative easing mainly aims to lower
Connected topics
Sources
- Mishkin (2018), Ch. 16Mishkin, F. S. The Economics of Money, Banking, and Financial Markets. 12th ed. Pearson, 2018. ISBN 978-1-292-26885-9.Nonconventional monetary policy tools, including quantitative easing and balance-sheet policy.