Do you ever wish you could just create money out of thin air? Snap your fingers and buy that new car cash? Well, then you should be a central bank because thanks to a relatively new (this century) financial technique known as Quantitative Easing the can do just that. Money out of thin air you say? How does that work? Well, loyal reader, I’m going to tell you. But like any good writer, I’m going to build up your anticipation first by stalling with an exposition dump.
You see the purpose of Quantitative Easing is to stimulate economic growth. And if you want to understand why central banks are turning to this new option then you need to understand what options they had available to them before.
Traditionally during economic downturns, governments attempt to spur economic investment in one of two ways. The first is with a massive dose of government spending on infrastructure. Invest in large construction projects for the public welfare and watch the money flow outward to the rest of the economy. The second is to lower interest rates to entice otherwise reluctant parties to take out loans and invest those loans back into the economy. There’s a sort of blind optimism to those approaches but I can get into that another day. Whether or not either of those approaches is effective is a conversation for another day. All that matters for this conversation are that those are the two major methods favored when attempting to stimulate dragging economies and that they are widely accepted practices.
But what happens when you’ve already passed a massive stimulus package and interest rates are at or quickly approaching zero? Well, it used to be that you were just shit out of luck and it was time to hunker down and weather the storm. But the advent of the digital age and the conversion of the majority of the world’s money from paper and coins to ones and zeros has created a new option for central banks: Quantitative easing.
So what is it? Well, basically Quantitative Easing is when a nation’s Central Bank creates new electronic money to purchase financial assets like government bonds back from private institutions (usually at an above market rate). The thing is unlike a private buyer for those bonds, who would have to use money that’s already in the economy to make their purchase, the central bank can just type in a couple of commands and invent the money out of thin air.
Now the seller has a whole bunch of cash in hand that they can invest back into the economy stimulating growth.
If it sounds like Quantitative Easing is just a fancy way of saying “printing more money but this time with computers” you’d be right. And it has the two major failings that printing money has. Inflation is the obvious problem here, pump in too much cash and you devalue your own currency, reducing growth rather than encouraging it. The central banks like to invest a great deal of time, money, and labor into creating advanced algorithm that helps them project the effect of different amounts of monetary infusion into the marketplace but the truth is there are a ton of variables here and all those fancy economic models don’t amount to much more than an educated guess. Still with highly targeted instances of Quantitative Easing inflation is not the biggest negative.
No, as always the largest problem lies with the banks receiving the money. You see the entire point of these exercises is to give the back enough fluid capital that it feels comfortable loaning it out to the little guy. Helping the middle-class invest in small businesses and home/automobile purchases. But if the Banks instead decide to take their sudden windfall and invest it in foreign emerging markets, commodities, or to shore up their own wobbly market position, the effect on the economy could be non-existent or even negative.
Look I’m not saying Quantitative Easing doesn’t work. Neither am I saying it does. I’m saying that the results so far have been a mixed bag and the jury is still out. And large infusions of cash into the money supply don’t change centuries of economic study on the subject simply because everything has gone digital. I’ll let you make your own judgments on the matter. Hopefully, now you have a pretty good idea what people mean when they talk about Quantitative Easing. Until next time this has been It’s The Economy Stupid.