Quantitative easing

Have you read about quantitative easing (QE) lately and wondered exactly what it was and how it is being used to combat the economic impacts of COVID-19? Below we provide a brief explanation.

The unconventional policy of QE has been around for a while, first pioneered by the Japanese following the bursting of their property and stock markets in the late 1980s, and honed by the US Federal Reserve and European Central Bank following the global financial crisis.

The Reserve Bank of New Zealand (RBNZ) made the decision to adopt Quantitative Easing after preparing the banks and financial markets recently. The RBNZ announced on Monday 23 March that it would conduct large-scale asset purchases of New Zealand government bonds (NZGBs) starting that week.

The RBNZ will purchase $30 billion of New Zealand Government Bonds with a range of maturities across the yield curve, over the next 12 months. This package is significant and paves the way for the government to announce further stimulus measures to support the economy over the rest of this year.

This move comes in addition to other measures announced recently to improve liquidity and the functioning of the monetary system in New Zealand.

The mechanics of QE are as follows:

  • The central bank electronically issues NZ dollars to itself (the modern version of money printing), and uses that money to buy securities (government bonds, corporate bonds, mortgaged backed securities, and in some cases even equities) from the market (usually from the banks). The cash proceeds from the sale of the bonds flow to the domestic banks, which can then lend it out, which should stimulate the economy. The central bank's balance sheet expands as it purchases bonds.

  • Once the central bank owns the bonds, it receives coupon payments, which it can reinvest back into the market by buying additional securities, thus maintaining adequate levels of liquidity.

  • The central bank holds onto the bonds until either economic conditions have strengthened enough to sell them back to the market, or the bonds mature and the government repays the face value to the central bank (at which time it might reinvest the proceeds into new bonds).

  • Increased demand for bonds from a central bank increases their price, which (because the coupons are fixed) reduces the bond yield.

  • The goal of QE is to buy enough bonds to bring bond yields down. Lower yields are meant to stabilise the financial system and encourage more risk taking and borrowing by consumers and businesses.

QE was previously billed as unconventional monetary policy. There were fears it could lead to inflation in the prices of goods and services. Over the last 10 years QE has become very conventional, and the only thing it inflated was asset prices. Central banks were tapering their QE a decade after the financial crisis. Amid the COVID-19 pandemic, the US Federal Reserve has announced renewed QE support, as has the European Central Bank and the Bank of England, and the Bank of Japan never stopped.


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