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What Is Quantitative Easing, in Plain Words

Quantitative easing is a central bank buying government bonds from the banks with money it creates, used when the policy rate is already near zero, so that long-term rates fall and money moves out into the markets; tightening is the reverse. This paper shows you QE in five plain lines; the idea as a canal lock whose upper pound can make its own water; the exchange as a warehouse with two doors; what it does to rates, as a bank standing on the far end of a diving board; and the weekly balance-sheet row on your platform, which sits beside the decision row and moves the years rather than the minute.

Difficulty
Beginner
Reading time
5 min
Pages
8
Reviewed by
Saman Rahbar

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QE in five lines

Quantitative easing is what a central bank does when its policy rate is already near zero and cannot go lower. It buys government bonds from the banks, and it pays with money it creates for the purpose. A bond is a loan to the government sold as paper, paying a fixed rate for years, and when the bank buys bonds by the trillion their price goes up and the rate they pay goes down; the banks that sold them now hold cash instead, which moves out into loans and markets. The reverse, letting the bonds run off or selling them, is tightening. The policy rate is the short end. QE is how the bank reaches the long end, when the short end is already on the floor.

A canal lock

Picture a canal lock. The upper pound is the central bank, which can make water; the lower pound is the banks and the markets. The gold sluice is quantitative easing: opened, and the lower level rises without any rain having fallen; shut and drained, and it falls again, which is tightening. The big gate is the policy rate, the ordinary way of moving boats between the levels, and the sluice is used when the gate is already as low as it goes. The water is money, and the point of the lock is that the level below can be raised from above, by a keeper who never has to wait for weather.

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