Quantitative easing – definition

Quantitative easing (QE) is a type of monetary policy which takes place when a central bank puts electronic money directly into the economy by purchasing long term financial assets (manly bonds) from banks or other organisations.

QE was introduced in response to the global financial crisis, during which interest rates were pushed down towards zero. At they approached zero new monetary policy instruments were required – hence the introduction of QE.

Purchasing bonds raises their price and reduces their yield (interest rates) [bond prices and yields are inversely related]. Other interest rates are driven down, and households and firms are more likely to spend or borrow, and hence aggregate demand is stimulated. Also, the new money injected into the system can be used to purchase shares and other financial assets, which raises the value of these holdings, and stimulates spending through a ‘wealth effect’.

In short, asset holders respond to the newly created money by rebalancing their portfolios by looking to invest the new money into higher value assets, such as shares.