Quantitative Easing is the unconventional monetary policy in which a central bank buys the government securities or other such securities from market in order to increase the money supply and to lower down the rate of interests. The money supply gets increased by flooding the financial institutions with capital in an effort to promote lending and liquidity. The lending rate gets increased and hence the flow of money also gets increased. It never includes the printing of new banknotes at all and this model is bought in use when money supply is flowing at a very low rate.
How to Model Quantitative Easing
1. Purchase or Sales of Government Bonds Takes Place:-
Quantitative easing includes the purchase or sales of government bonds or securities in order to bring about the supply of money to increase about the rate of landing. The government bonds are purchased and this lowers down the short term interest rates. The approach stays effective till interest rates do not approach a zero.
2. When Interest Rates Approach a Zero:-
I told you earlier also that it is the Central Bank which is responsible for quantitative easing. Now the approach of this bank is just to enhance the flow of capital by hook or by crook and it succeeds in its job as well but only till the interest rates do not approach a zero. Once these interest rates approach a zero, the bank strategy will lose its effectiveness and it will have to try other strategic attempts in order to stimulate the economy of nation.
3. Targets of Quantitative Easing:-
The approach of quantitative easing targets the commercial banks, the private sector assets, the financers etc. in order to stimulate the economy. With quantitative easing, the banks get encouraged to lend money and this generates about the increase of money supply. Flow of money supply in turn makes a significant effect on the economy of a nation and thus it gets stimulated.
4. Sometimes It Can Lead To Higher Rates of Inflation:-
Quantitative easing can sometimes lead to higher rates of inflation. This happens when the supply of money increases too quickly within the commercial banks and finance firms. Actually, the central bank encourages such bodies to lend money as much as they can and this generates a flow of capital. Now more money supply takes place and this takes place too quickly and this can lead to higher rate of inflation.
5. Why There Is a Risk of Inflation with More Flow of Capital:-
Though Central bank gets succeeded in its motive of enhancing the flow of capital within the nation with quantitative easing but this brings about an excessive flow of capital within an economy. Now there is still a fixed amount of goods to be sold but there is a large amount of capital in hands of people. This is what brings about the risk of inflation.
6. Inflation Ensured Not To Fall Below A Target:-
Though I have told you earlier that with a limited amount of goods to be sold, but a great amount of capital to be available with people, a risk of inflation gets generated but with the same concept or approach of quantitative easing, we can ensure that inflation does not fall below a specific target and thus it can prove to be an advantage if we are capable to control it in a desired manner. This makes this policy a more effective model for an economy.