What is Quantative Easing?
Central banks use quantitative easing (QE) to boost the money supply by purchasing government bonds and other securities. Lowering interest rates is achieved through increasing the availability of money.
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Banks can lend under more favorable conditions when interest rates are low. Because central banks use such methods as a last-resort, quantitative easing policies are often initiated when interest rates are already near zero.
To learn more about central banks in particular, have a read of our article What is a Central Bank? To learn more about QE in particular, read on.
Definition of Quantitative Easing
Quantitative easing is a monetary strategy in which a central bank acquires specified amounts of government bonds or other financial assets to pump money into the economy in an attempt to stimulate economic growth.
Central Bank Monetary Policy
Quantitative easing is a tool of monetary policy used by central banks to rapidly increase the supply of domestic money and stimulate economic activity.
Quantitative easing often entails the central bank of a country increasing its money supply by acquiring longer-term government bonds and other forms of assets. If quantitative easing ceases to be successful, the government is left with the option of fiscal to increase the money supply.
Effects of Quantitative Easing on Financial Markets
Since longer-term investors have little to no risk-free profits to obtain with rates so low, they are often pushed to riskier investments in search of yield. Many of these investors’ portfolios are heavily weighted toward equities, which drives up stock market values.
Falling interest rates also impact the decisions taken by public corporations. Reduced rates imply lower borrowing expenses and can be good for growth, since expanding their business will be cheaper than ever.
Although the primary goal of quantitative easing is to sustain price levels or inflation, these policies can have a significant negative impact, leading to high levels of inflation owing to more expensive commodities. If commercial banks fail to lend extra reserves, the money markets may become unbalanced.
The introduction of QE has greatly influenced Bitcoin and Ethereum (the two most prominent cryptocurrencies) as well as the market more broadly. When the Fed resumed quantitative easing policies in response to the COVID-19 pandemic, the price of Bitcoin versus the US dollar rose from a low of 3,500 (after crashing more than -50% over the course of 2 days) to print all time highs that same year, hitting a high of 65k by the second quarter of 2022.
Some traders and investors tout BTC as an inflation hedge due to its deflationary characteristics, however this can be now refuted by the opposite camp after the cryptocurrency’s recent “rising interest rate tantrum”. If you want to know more about how assets react to changes in interest rates, check out our Guide to Interest Rates.
Increasing a more conventional type of monetary policy, quantitative easing (QE) involves a central bank (such as the Federal Reserve) purchasing an enormous amount of long-term securities on the open market to stimulate lending and investment and increase the money supply.
For these reasons, it is vital even for order flow traders to understand, since quantitative easing policies can have both short and long-term effects on asset prices.
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