Usually, central banks try to raise the amount of lending and activity in the economy indirectly, by cutting interest rates.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower, a central bank's only option is to pump money into the economy directly. That is quantitative easing (QE).
The way the central bank does this is by buying assets - usually financial assets such as government and corporate bonds - using money it has simply created out of thin air.
The Bank is injecting money directly into the economy to meet the inflation target.
Of course that’s preposterous. The banking system is awash in liquidity. Banks used to hold about $2 billion dollars of excess reserves. Now, they have about a trillion. If they didn’t lend out this first trillion of extra cash, why would they lend the next $600 billion? Money or “liquidity” in the economy is like oil in a car. Not enough oil, and the car seizes. Once you have enough, you can’t make the car run faster with more oil.
So much for the claim that QE will revitalize the economy. What about the danger of inflation and devaluation? Sorry, that claim also falls apart on the same hard fact. Buying long-term debt and giving banks money, now that interest rates are zero, can have no more effect on inflation or devaluation than buying long term debt and giving banks short-term debt. The money is not “money,” which banks try hard to get rid of because they lose interest. Money now is the same thing as debt, held as an asset.
The Roman emperors did their own quantitative easing by melting down their 100% silver coins and adding cheaper metals? Successive emperors did this so they could pay their troops and by the third century there was less than 5% real silver left in the coins so they became almost worthless
The most usual approach is large-scale purchases of debt. The effect is the same as printing money in vast quantities, but without ever turning on the printing presses. The Fed buys government or other bonds and writes down that it has done so — what is called “expanding the balance sheet.” The bank then makes that money available for banks to borrow, thereby expanding the amount of money sloshing around the economy thereby, it hopes, reducing long-term interest rates.
The initial quantitative easing program saw the Fed buy $1.75 trillion in debt held by Fannie Mae and Freddie Mac; mortgage-backed securities and Treasury notes between November 2008 and May 2010. A second round, dubbed QE2, involved an additional $600 billion in long-term Treasury securities purchased between November 2010 and June 2011.
The Bank of England have left interest rates on hold and decided against extending the existing £325 billion program of Quantitative Easing (QE). Despite the International Monetary Fund (IMF) calling for a cut in UK interest rates the decision to leave rates at 0.5% was hardly a surprise. ‘Wait & see’ The IMF also suggested that the Bank should extend the program of QE and some observers had predicted that this advice would be followed.
“The soaring unemployment rate is a lagging indicator of the financial problems in the euro zone, and is not terribly surprising given all the bad news coming from Europe in the last couple of years. I think it adds fuel to the arguments for further quantitative easing in the eurozone. More cheap money from the ECB could be taken as a positive for Russia, for example, because it would likely support commodity prices,” says Jason Hurwitz senior financial analyst at Alfa Bank.