Primer: What is Quantitative Easing (QE)?

 

Quantitative easing (QE) is an unconventional monetary policy used by central banks to stimulate the national economy when conventional monetary policy has become ineffective. Quantitative easing increases the money supply by flooding financial institutions with capital, in an effort to promote increased lending and liquidity.

Why QE?

All the major countries like the US, Japan, Euro zone and the UK have opted QE or monetary easing with the aim of infusing more liquidity into the system so as to push the inflation rate higher and stimulate the growth.

Who initiated it?

The original expression of Quantitative Easing was used for the first time by the central bank of Japan. Nearly two decades ago, the Japanese economy was mired in a crisis bearing a close resemblance to the Great Recession. As the crisis unfolded, the BoJ faced an unprecedented array of challenges. So the Central bank, through its monetary policy tool, started to channelise and pump money into the economy.

Effects of QE: Positive Effects:

It helps in stimulating the domestic economy as more liquidity is present in the system.

The banks are able to lend more which further supports the expansion and development of the industries.

Negative Effects:

It may cause higher inflation if the amount of easing required is overestimated and too much money is created by the purchase of liquid assets.

It may fail to be effective if banks remain reluctant to lend money to businesses and households.

Increasing the money supply tends to depreciate a country’s exchange rate versus other currencies. And the devaluation of the currency harms the importers as the cost of imported goods is inflated.


Rupee : Effects of QE

The Quantitative easing adopted by US has helped the Indian economy as a huge amount of flows have seen their way to Indian markets. However the recent talks of tapering the QE are posing a greater risk as it will mean a sudden outflow from our country. It will not only affect the stock markets but also the rupee. Till the year 2011, US had printed $2.9 trillion whereas Japan had purchased assets worth $1.8 trillion.

If the US stops printing money, then the US treasury yields will go up and US dollar will gain. This will push the emerging markets’ currencies like Indonesian rupiah, Brazilian real lower and even the Indian rupee will feel the heat.





Source: India Forex Advisors