What is quantitative easing?

Quantitative easing is a tool that central banks, like us, can use to inject money directly into the economy.

Money is either physical, like banknotes, or digital, like the money in your bank account. Quantitative easing involves us creating digital money. We then use it to buy things like government debt in the form of bonds. You may also hear it called ‘QE’ or ‘asset purchase’ – these are the same thing.

The aim of QE is simple: by creating this ‘new’ money, we aim to boost spending and investment in the economy.

How does quantitative easing work?

Large-scale purchases of government bonds lower the interest rates or ‘yields’ on those bonds (the investopedia website explains more about bond yields). This pushes down on the interest rates offered on loans (eg mortgages or business loans) because rates on government bonds tend to affect other interest rates in the economy.

So QE works by making it cheaper for households and businesses to borrow money – encouraging spending.

In addition, QE can stimulate the economy by boosting a wide range of financial asset prices.

Suppose we buy £1 million of government bonds from a pension fund. In place of the bonds, the pension fund now has £1 million in money. Rather than hold on to this money, it might invest it in financial assets, such as shares, that give it a higher return. And when demand for financial assets is high, with more people wanting to buy them, the value of these assets increases. This makes businesses and households holding shares wealthier – making them more likely to spend more, boosting economic activity.