A country's monetary policy defines the policies its central bank employs to control its money supply. Usually, the bank does so to achieve macroeconomic goals. In this process, the central bank manages the growth and volume rate of the money supply in the economy. There are several steps involved in establishing a monetary policy for a country.
The primary control source using the monetary policy is money supply and interest rates. Using these, the central bank can also dictate other factors such as the country's growth, consumption, and inflation rates. There are several strategies that the central bank can use when establishing a monetary policy. One such policy is quantitative easing. However, it is not as prevalent as other techniques.
What is Quantitative Easing?
Quantitative easing is a strategy used by a country’s central bank when establishing a monetary policy. The bank acquires long-term securities from its member banks. By doing so, the central bank releases money into the economy. This technique causes the interest rates in the economy to fall. Therefore, it increases the money supply to decrease interest rates.
Unlike some other techniques, quantitative easing isn't as prevalently used by the central bank. It is considered a non-traditional policy. Quantitative easing aims to encourage investment and borrowing by decreasing interest rates. On top of that, it provides banks with better liquidity. Some central banks may utilize quantitative easing to lower their fund rate to zero.
How does Quantitative Easing work?
When establishing a country's monetary policy, a central bank can use several techniques. With quantitative easing, the central bank picks all government securities from its member banks. These may include commercial banks or even private financial institutions. Through this, the central bank releases a money supply into the economy, causing a decrease in short-term interest rates.
The decline in short-term interest rates encourages individuals to borrow funds. Similarly, the prices of financial assets in the market also rise, further benefiting investments. Since the member banks receive a money stream, they can use it to increase their lending activities. As a result of the increase in money supply, the interest rates decrease.
On top of that, quantitative easing can also have other benefits. One of these comes from its effect on the country's currency. As this technique keeps the currency's value low, it also makes investments attractive to foreign investors. Similarly, the exports increase as the lower currency value makes it a viable option. Overall, quantitative easing can have several impacts on a country’s economy.
What are some limitations of Quantitative Easing?
While quantitative easing can be significantly beneficial, it also comes with some limitations. Firstly, it relies on member banks to reuse the money supply for lending activities. Some banks may, however, choose to invest this amount instead. While it may be beneficial in other ways, it does not achieve the objective of quantitative easing.
Similarly, quantitative easing requires governments to control and overlook the process. If the central bank causes a sudden increase in money supply, it may have detrimental effects. Furthermore, while this technique can increase imports, it may also damage the country's import industry.
Conclusion
A country's monetary policy dictates its money supply and interest rates. Usually, the central bank is responsible for setting this policy. One technique they can use for monetary policy is quantitative easing. Quantitative easing allows the central bank to acquire long-term securities from its member banks. By doing so, it releases the money supply while also decreasing interest rates.
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