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What is the Quantitative Easing?

Quantitative Easing, QE, economy, inflaction

Quantitative Easing, QE, economy, inflactionMany times you have heard or read about Quantitative Easing, but what exactly is it? To have money to support their economy, their services and their activities, the States issue bonds that can be purchased by citizens and businesses, including banks.

Simplifying: periodically, a State offers bonds that cost X dollars/euro/pound… with an expiry and commits itself to returning the money to those who bought those bonds by adding a percentage of interest when it is expired.

Those who buy bonds cannot get the money they invested more interest until they expire, but if they want, they can sell them on the market, or for earning something, or for not to lose too much, in case there are real risks that bonds cannot be repaid to their expiration from who issued them.

Among the major buyers of these bonds, there are the banks, which therefore have large amounts of money tied up because invested in bonds (not just of the State). To create currency, i.e. to ensure that there will be more money in circulation to get loans from banks and to make investments more easily, a central bank may decide to resort to Quantitative Easing. In practice, it proposes at the banks to repurchase bonds, usually starting with junk bonds, hoping that with the money obtained from the sale, individual banks will make it easier for people the access to credit, i.e. the possibility for their customers, citizens and businesses, to borrow money more easily and lower interest rates.

Quantitative Easing has several consequences, usually related to the economic context in which it is realized. Among the most common, there is the impact on the cost of living and currency buying power. In short: putting more money into circulation with operations such as a QE, has reduced the value of the currency (it is devalued: there is more money and this affects demand) and as a result price increase because the money they make purchases is worthless. This is why inflation is rising, something generally perceived as a negative because it raises prices, but the central banks know well that a minimum of inflation is positive in order to avoid deflation, that is in a progressive decline in prices.

With Quantitative Easing, thanks to the increased availability of money, the interest rates that the countries guarantee for their bonds to those buying them, it should decrease with respect to new issues (and for floating rates), thereby helping to create less new debt in the countries concerned (promising less interest, the money to be returned on the maturity date is lower). Things were different for debts already contracted with securities issued in the past. In this case, getting the inflation going again, money costs less and it becomes less expensive, for them, repay the debt.

Governments could, therefore, afford to spend more money by increasing the public expenditure on various short-term and medium to long-term activities. In the first case, policies to encourage and stimulate employment and consumption, in the second by investing money in infrastructure construction, from roads to railways, passing through those for telecommunications.

Another consequence of the Quantitative Easing should be currency devaluation. This means that the goods that the country exports will cost less, which is positive in order to increase the level of exports, but at the same time the currency will have less purchasing power. Some goods could cost more, for example, for the countries of the Eurozone, the crude oil, because its price is in dollars and there is, therefore, the exchange rate with the US currency (if the Euro devalues, you need more Euro to change them in dollars). Consumption, especially in countries that import many goods, may be affected, especially if to an inflation increases will not be matched by an increase in the employment.

 

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