What Is the Fed's Quantitative Easing?

Quantitative easing is when a central bank buys long-term government bonds. What does that mean? To understand it, you first need to understand the monetary policy that central banks carry out.

Central Bank Monetary Policy

Central banks pursue economic stability at home and abroad through a variety of monetary policies. One of a central bank's key roles is setting the base rate. The base rate is the interest rate that serves as the benchmark for the market. Around this benchmark, when actual interest rates fall below the base rate, the central bank withdraws money, and when they rise above it, the central bank puts money into circulation. When there is less money liquidity in the market, interest rates rise according to the law of supply and demand, and in the opposite case, interest rates rise.

The base rate, one of a central bank's key monetary policy tools, is determined by the central bank's policy. Usually, central banks tend to lower interest rates when the economy is struggling and raise them when inflation is too high.

To sum up, a central bank sets the base rate and, through very short-term market rates, tries to steer long-term interest rates and corporate bond yields.

The 2008 Financial Crisis and COVID-19 in 2020

The 2008 financial crisis and COVID-19 in 2020 dealt a huge shock to the market, and businesses and households tried to keep going by taking on more loans. As a result, both short-term and long-term interest rates trended upward, so the central bank stepped in to bring rates down and started printing money. This is what quantitative easing is. The central bank set the base rate close to 0% and began supplying money almost without limit. When this happens, money floods into the market and both short-term and long-term interest rates fall.

This brought short-term rates down, but a problem arose: because of a negative outlook on the market's future, long-term rates did not fall. In response, the Fed adopted a quantitative easing policy, buying long-term government bonds to pump money into the market.

The Fed's Quantitative Easing

When COVID-19 broke out, the US Federal Reserve began printing enormous amounts of dollars in the 10-year rate market, backed by long-term government bonds. Previously, it had only bought short-term government bonds, but the Fed made this choice because worsening market sentiment kept long-term rates from falling. In other words, it printed money while buying long-term bonds, and through this it lowered interest rates. Let's sum it up once more. Quantitative easing is a central bank policy that aims to cut interest rates by buying government bonds and supplying money.

The Fed usually buys short-term government bonds, but this time it also bought long-term ones. In the future, it might even buy corporate bonds from companies like Google and Apple. This kind of case is called qualitative easing (QE).

Wrapping Up

Does that make sense? Quantitative easing is a policy in which the central bank prints more money to guide market interest rates down in line with the base rate it has set. In English it's called QE (Quantitative Easing). The Fed prints money and uses it to buy government bonds, putting money into circulation in the market. From November 2008 to 2010, a total of 1.7 trillion dollars in additional money was released.