Quantitative easing

Based on Wikipedia: Quantitative easing

The Money Printer Goes Brrr

In March 2020, as the world locked down and economies ground to a halt, the United States Federal Reserve announced it would conjure roughly seven hundred billion dollars into existence. Not through taxation. Not through borrowing. Through the simple act of creating new money and using it to buy financial assets from banks.

This is quantitative easing.

The phrase sounds deliberately obscure, like something designed to put you to sleep in an economics lecture. But what it describes is one of the most extraordinary powers any institution can wield: the ability to create money from nothing and inject it directly into the financial system. When central banks deploy this tool, they are making a bet that printing money today will prevent economic catastrophe tomorrow.

Sometimes that bet pays off. Sometimes it creates new problems. Understanding how quantitative easing works—and why it exists at all—means understanding why traditional monetary policy occasionally hits a wall, and what happens when the people running the economy decide to break through it.

How Interest Rates Normally Steer the Economy

Before we can understand quantitative easing, we need to understand what it replaces.

Central banks like the Federal Reserve, the Bank of England, or the European Central Bank have one primary tool for influencing the economy: interest rates. When the economy runs too hot and inflation rises, they raise interest rates. This makes borrowing more expensive, which slows down spending and investment. When the economy slumps and unemployment rises, they lower interest rates. Cheaper borrowing encourages businesses to expand and consumers to spend.

This works through a specific mechanism. Central banks buy and sell government bonds—essentially IOUs issued by the government—on the open market. When they buy bonds, they're injecting money into the banking system. When they sell bonds, they're pulling money out. These transactions shift the supply of money available for banks to lend to each other overnight, which in turn affects the interest rate banks charge each other for these short-term loans.

That overnight rate ripples outward through the entire economy. It influences mortgage rates, car loan rates, credit card rates, and the rates businesses pay to borrow for expansion. Central bankers adjust this lever constantly, nudging the economy toward their targets for employment and inflation.

The system works well enough most of the time. But it has a fundamental limitation.

The Zero Bound Problem

Interest rates cannot easily go below zero.

Think about what a negative interest rate would mean. If you lent someone a hundred dollars at negative five percent interest, they would pay you back only ninety-five dollars. Why would anyone lend money under those conditions? They would be better off stuffing cash in a mattress.

This creates what economists call the zero lower bound. When a recession hits and the central bank starts cutting interest rates, it can only cut so far. Once rates approach zero, the traditional tool stops working. It's like a thermostat that can't be turned down below a certain temperature—you're stuck with whatever temperature you've got.

This situation has a name: the liquidity trap. When interest rates hit zero, people and businesses prefer to hold cash rather than invest it. After all, if you're earning essentially nothing on your investments, why take any risk at all? Better to stay liquid—to keep your money where you can access it immediately.

Japan discovered this problem first. In the late nineteen-nineties, the Japanese economy fell into a prolonged slump. The Bank of Japan cut interest rates to zero. The economy remained stuck. Deflation set in—prices actually started falling year over year. This sounds like it should be good for consumers, but deflation is economic poison. When people expect prices to drop, they delay purchases. Why buy a car today if it will cost less next month? This waiting game causes spending to collapse, which pushes prices down further, which encourages more waiting. The economy spirals downward.

By 1999, Japan had essentially run out of conventional ammunition. Interest rates were at zero. The economy refused to recover. The Bank of Japan needed something new.

Inventing a New Tool

The term quantitative easing was coined by an economist named Richard Werner in 1995, but it took a few more years before any central bank was desperate enough to try it.

In March 2001, the Bank of Japan became the first major central bank to officially implement quantitative easing. The concept was straightforward in principle, even if the execution was complex. Instead of trying to lower interest rates—which were already at zero—the Bank of Japan would buy large quantities of financial assets, flooding the banking system with new money.

The mechanics work like this. A central bank announces it will purchase, say, one hundred billion dollars worth of government bonds. It doesn't raise this money through taxes or borrowing. It simply creates new money in its computers—digital entries in bank accounts that didn't exist moments before—and uses this freshly created money to buy bonds from private banks and financial institutions.

The sellers of these bonds—commercial banks, pension funds, insurance companies—now find themselves holding cash instead of bonds. In theory, this cash burns a hole in their pockets. They want to earn a return on it, so they look for other investments. They might buy corporate bonds, stocks, or real estate. They might lend more money to businesses and consumers. All of this additional activity stimulates the economy.

There's another effect. When the central bank buys massive quantities of bonds, it drives up bond prices. When bond prices rise, their yields fall. This pushes down long-term interest rates across the economy, making it cheaper for businesses to borrow for major investments even when short-term rates are already at zero.

The Bank of Japan started by increasing commercial bank reserves from about five trillion yen to thirty-five trillion yen over four years—roughly a sevenfold increase. It bought not just government bonds but also asset-backed securities, equities, and commercial paper. The intervention was unprecedented in its scale and scope.

Did it work? The results were mixed. Japan's economy stabilized but never really boomed. Deflation persisted. Critics argued that quantitative easing had failed to deliver on its promises. But when the 2008 financial crisis struck the West, central bankers found themselves in the same predicament Japan had faced a decade earlier. With interest rates at zero and economies collapsing, they reached for the same tool.

The American Experiment

The Federal Reserve's response to the 2008 financial crisis would make Japan's quantitative easing look modest by comparison.

Before the crisis, the Fed held between seven hundred and eight hundred billion dollars in Treasury notes on its balance sheet. This was the accumulated result of decades of normal monetary operations. By June 2010, the Fed's balance sheet had swelled to over two trillion dollars. The central bank had more than doubled its holdings in less than two years.

The Fed's quantitative easing came in waves, each with its own nickname.

The first round, which would later be called QE1, began in November 2008. The Fed announced it would buy six hundred billion dollars in mortgage-backed securities—the very financial instruments at the heart of the crisis. By March 2009, it had expanded its purchases to include bank debt and Treasury notes, eventually accumulating one point seven five trillion dollars in various assets.

When the economy showed signs of recovery, the Fed paused. But the recovery sputtered, and in November 2010 came QE2: another six hundred billion dollars in Treasury purchases. The nickname caught on in the financial press and became shorthand for this second wave of money creation.

QE3, launched in September 2012, was different. Instead of announcing a fixed total, the Fed committed to buying forty billion dollars per month in mortgage-backed securities indefinitely—with no predetermined end date. This open-ended commitment earned it the sardonic nickname "QE Infinity." The Fed was signaling that it would keep printing money until the economy truly recovered, however long that took. By December 2012, the monthly purchases had increased to eighty-five billion dollars.

The tapering began in 2014. By October of that year, the Fed had accumulated four and a half trillion dollars in assets—more than five times its pre-crisis holdings.

Then came 2020.

The Pandemic Response

When COVID-19 shut down the global economy in March 2020, the Federal Reserve moved with extraordinary speed. Within days of the World Health Organization declaring a pandemic, the Fed announced a new round of quantitative easing—approximately seven hundred billion dollars in asset purchases to maintain liquidity in financial markets.

But the initial announcement was just the beginning. Over the following months, the Fed expanded its purchases dramatically. By mid-2022, this fourth round of quantitative easing had added roughly two trillion dollars to the Fed's balance sheet.

The United Kingdom followed a similar pattern. The Bank of England began its quantitative easing program in March 2009, initially purchasing about one hundred sixty-five billion pounds in assets. Through successive rounds over the following decade, its holdings grew to nearly nine hundred billion pounds by November 2020.

The European Central Bank was slower to embrace quantitative easing explicitly. It had been buying assets since 2009, but its leadership long refused to acknowledge these purchases as quantitative easing. In January 2015, under Mario Draghi's leadership, the ECB finally dropped the pretense and announced a full-scale quantitative easing program.

What Quantitative Easing Actually Does

Understanding the theory behind quantitative easing is one thing. Understanding its real-world effects is considerably more complicated.

The intended effect is clear enough. By purchasing large quantities of financial assets, central banks aim to lower long-term interest rates, encourage lending, boost asset prices, and stimulate spending. When stocks and real estate become more valuable, people feel wealthier and more willing to spend. When borrowing becomes cheaper, businesses invest and expand. The extra money sloshing through the financial system finds its way into the real economy.

But critics point out several problems with this transmission mechanism.

First, there's what economists call the portfolio balance channel. When the central bank buys government bonds, investors who would normally hold those bonds are pushed into other assets—corporate bonds, stocks, real estate. This drives up prices for these assets too. In theory, higher asset prices encourage economic activity. In practice, they primarily benefit people who already own substantial assets. The wealthy get wealthier. Those without assets see few benefits.

Second, quantitative easing only works if banks actually lend out the money they receive. If banks simply park their new reserves at the central bank, earning a small but safe return, the money never reaches the real economy. This happened to some degree in both Japan and the United States. Banks, burned by the financial crisis, became extremely cautious about lending. The money the Fed created sat in bank reserves rather than flowing to businesses and consumers.

Third, there's the risk of creating asset bubbles. When central banks pump trillions of dollars into financial markets, that money has to go somewhere. Stock prices rise. Real estate prices rise. Cryptocurrency prices rise. These increases may or may not reflect actual improvements in the underlying economy. If they don't—if prices are rising purely because of cheap money rather than genuine value creation—then a painful correction becomes inevitable.

The Inequality Question

Perhaps the most persistent criticism of quantitative easing concerns its distributional effects. Who benefits from all this newly created money?

The Bank of England itself acknowledged the problem in a 2012 analysis. Quantitative easing, the Bank concluded, benefited households differently depending on what assets they held. Richer households, which own more stocks and real estate, saw their wealth increase substantially. Poorer households, which hold their savings primarily in bank accounts earning near-zero interest, gained little or nothing.

Consider what happens when the central bank's purchases push up stock prices. Someone with a substantial investment portfolio watches their net worth climb. Someone with no investments sees no benefit but does face higher housing costs as real estate prices rise too. The wage worker renting an apartment experiences quantitative easing primarily as higher rent.

Central bankers respond that without quantitative easing, the alternative would have been worse: a deeper recession, higher unemployment, and economic misery that would have hurt workers more than rising asset prices. This may well be true. But it doesn't change the fact that the immediate beneficiaries of quantitative easing are disproportionately those who already hold substantial wealth.

The Exit Problem

What goes up must come down—or so the theory goes. Quantitative easing is supposed to be temporary, an emergency measure deployed during crises and withdrawn when conditions normalize. The reversal even has its own name: quantitative tightening.

In quantitative tightening, the central bank sells off the assets it accumulated during quantitative easing, pulling money out of the financial system rather than injecting it. This should raise interest rates, cool asset prices, and return monetary policy to normal.

The problem is that unwinding quantitative easing turns out to be extremely difficult.

Financial markets become addicted to easy money. When the Fed merely hinted in June 2013 that it might slow down its bond purchases—not stop them, just slow them down—stocks plunged. The Dow Jones Industrial Average dropped six hundred fifty-nine points over three trading days. This market tantrum, dubbed the "taper tantrum," demonstrated how dependent markets had become on continued Fed support.

The Bank of England announced in February 2022 that it would begin winding down its quantitative easing portfolio. Initially, it planned to let maturing bonds roll off naturally without replacing them, then accelerate the process through active sales. But in September 2022, just as the Bank was preparing to start selling bonds, a crisis in UK government debt markets forced it to reverse course. Instead of selling bonds, the Bank announced emergency purchases of long-dated gilts—British government bonds—to prevent a market meltdown.

The episode illustrated a fundamental tension. Central banks want to normalize policy after years of emergency measures. But every time they try to withdraw support, markets threaten to collapse. The patient has become dependent on the medicine.

The Inflation Question

For years, critics warned that quantitative easing would inevitably cause inflation. After all, if you dramatically increase the money supply, shouldn't prices rise?

For a long time, the predicted inflation never materialized. The 2010s saw historically low inflation despite unprecedented money creation. Central bankers pointed to this as vindication: quantitative easing had stabilized the economy without igniting an inflationary spiral.

Then came 2021 and 2022.

Inflation surged in the United States, the United Kingdom, and Europe. Consumer prices rose at rates not seen in four decades. Suddenly, the warnings that had seemed overblown for years appeared prescient. Had all that money creation finally caught up with us?

The answer is complicated. The post-pandemic inflation had multiple causes: supply chain disruptions, labor shortages, the war in Ukraine, and yes, the enormous fiscal and monetary stimulus unleashed during the pandemic. Disentangling how much of the inflation came from quantitative easing versus other factors is extraordinarily difficult.

What's clear is that the assumption underlying quantitative easing—that it could be deployed indefinitely without inflationary consequences—proved wrong. The money created during the pandemic eventually did drive up prices, at least in part.

The Bubble Warning

Justin Yifu Lin, a former chief economist at the World Bank and current dean at Peking University, has warned that the United States is experiencing an artificial intelligence bubble inflated by years of easy money. He predicts this bubble will burst within five years, potentially triggering another international financial crisis.

Whether Lin's specific prediction proves accurate, his underlying concern reflects a broader worry about quantitative easing. When central banks create trillions of dollars and that money flows into financial assets rather than productive investment, prices can detach from reality. Technology stocks, cryptocurrencies, and other speculative assets have soared during the era of quantitative easing. Some of this reflects genuine innovation and value creation. Some of it reflects too much money chasing too few investment opportunities.

The history of financial crises suggests that prolonged periods of easy money and rising asset prices often end badly. The dot-com bubble of the late nineteen-nineties, the housing bubble of the mid-two-thousands—both occurred during periods when credit was plentiful and asset prices seemed to only go up. Quantitative easing may have prevented a depression in 2008 and 2020, but it may also have set the stage for the next crisis.

A Tool Without Good Alternatives

For all its flaws, quantitative easing persists because the alternatives seem worse.

When a severe recession hits and interest rates are already at zero, central banks face an unpleasant choice. They can sit on their hands and let the recession deepen, with all the human suffering that entails—mass unemployment, business failures, foreclosed homes. Or they can create money and try to stimulate the economy, accepting the risks of asset bubbles, inequality, and eventual inflation.

In practice, central bankers consistently choose the second option. The immediate visible harm of a depression outweighs the diffuse future risks of too much stimulus. Politicians and the public would never forgive central bankers who did nothing while the economy collapsed. So they print money, buy assets, and hope the long-term consequences remain manageable.

This dynamic creates what economists call moral hazard. Financial market participants know that whenever things get bad enough, central banks will ride to the rescue with more quantitative easing. This knowledge encourages risk-taking. Why worry about a crash when you know the Fed will step in to prop up prices? The expectation of future bailouts makes the behavior that leads to crises more likely.

Japan, where quantitative easing began, offers a cautionary tale. More than two decades after the Bank of Japan first deployed this tool, the country has never fully escaped its economic malaise. Interest rates remain at zero. The central bank's balance sheet has ballooned to enormous size. Japan has become dependent on continuous monetary stimulus just to maintain economic stability. Some economists worry that the United States and Europe are heading down the same path—trapped in a world where emergency measures become permanent because the economy can no longer function without them.

The Ongoing Experiment

Quantitative easing remains, in many ways, an experiment. The tool was invented less than thirty years ago. Its long-term consequences remain unknown. Central bankers are flying blind, adjusting their approach based on real-time feedback rather than established theory.

What we know is this: quantitative easing can prevent financial panics from spiraling into depressions. It can lower long-term interest rates and boost asset prices. It can buy time for economies to heal from shocks.

What we also know is this: quantitative easing exacerbates inequality. It may inflate asset bubbles. It creates dependencies that are difficult to unwind. And it may ultimately contribute to inflation that erases some of its initial benefits.

The fundamental question—whether quantitative easing does more good than harm in the long run—remains unanswered. We won't know for certain until we see how the next few decades unfold. Did the trillions of dollars created after 2008 and 2020 prevent catastrophe, or did they merely delay a larger reckoning?

For now, central banks continue to treat quantitative easing as an essential tool in their kit, ready to be deployed whenever the next crisis strikes. Given the challenges facing the global economy—from pandemic aftershocks to climate change to geopolitical instability—that next crisis may not be far off. When it arrives, central bankers will face the same impossible choice they've faced before: do nothing and watch the economy burn, or print money and hope for the best.

The money printer stands ready.