It may sound silly, but our economy is being sustained by the growth in debt. However, bubbles arise from time to time, as evidenced by the housing crisis in the US that struck in 2008. The massive sale of complex financial products based on poor quality mortgages, then created a bubble and eventually led to a stock market crash and the global recession of 2008-2012.
The central banks then attempted to rekindle the economy by lowering the interest rate, based on the idea that being able to borrow more cheaply makes saving less interesting and stimulating spending. But there was no success. The central banks in the European Union, the United Kingdom, the US and Japan therefore decided to take a different approach by doing quantitative easing.
What is quantitative easing?
Central banks such as the US Federal Reserve and the European Central Bank (ECB) are the exclusive issuers of money – they print bills and melt coins. They are also the only agencies in the world that are allowed to print money to help stimulate the economy.
Quantitative easing therefore comes down to ‘printing’ money. We put the last word in quotation marks, because in reality the central banks simply adjust their digital accounting. With the ‘new money’ they then buy all kinds of debts from other financial institutions, but also governments (government bonds). In this way, the central banks actually become lenders with money that they have created themselves. Quantitative easing in this form was first applied during the 2008-2012 recession.
Why is no ‘real’ money being printed?
The reason why quantitative easing does not mean that banks simply print money is the danger that inflation might return much earlier than expected and in a very unbalanced way. Consider, for example, prices that rise much faster than wages. The economic situation would then only get worse. Quantitative easing, however, ensures that money is injected back into the economy through a single port, namely the commercial banks, because the ‘new money’ is used to purchase bonds from the commercial banks.
Markets get breathing space again
By reselling their bonds to the central banks, commercial banks receive fresh money and transfer their risk of default to the central banks. Because they have the necessary breathing room again, they can once again start lending money to individuals and companies. Quantitative easing thus stimulates economic growth, at least in theory.
What is the result of quantitative easing today?
For the time being, it appears that quantitative easing will prove to be a success, but the current result will only be clearly apparent within a few years. We are currently still in the completion phase of the various purchase programs.