Mar
03
2009

Is “Quantitative Easing” the same as “printing money”?

Image by azrainman - CC-BY

Image by azrainman - CC-BY

The phrase “printing money” is loaded with all kinds of negative connotations. It’s something we associate with Robert Mugabe, destroying the value of Zimbabwe’s currency. But now “quantitative easing” is about to begin. How does that work, and is it really the same as printing money?

Most of the money in circulation is not in the form of banknotes, but in the form of currency balances held electronically by the banks. That doesn’t alter the essence of what’s happening, because the banks are free to go to the central bank at any time and exchange their currency balance for crisp fresh banknotes. A central bank can “print money” without literally firing up the printing presses.

When a central bank such as the Bank of England undertakes quantitative easing, it means they are creating fresh money and buying stuff with it. So the central bank runs its software and credits an amount to its balance. Yep, just out of nowhere. Central banks are the only banks that can “magic up” a bank balance, just like that.

But the central bank funds have no effect on the economy until they get “out there”. So the central bank uses those funds to buy stuff. The central bank gets the stuff, and the seller gets the money transferred into their bank balance, from which they can spend or lend it just like any other money. The effect is to get more money into circulation.

So what is this “stuff” that the central bank buys? Some economists would say that the bank is buying “assets”, but economists have a broader notion of “assets” than the “man in the street” does. The bank might buy government bonds (which is really just lending money to the government). Or the bank might buy corporate bonds (which is really just lending money to a company). Or the bank might buy debentures from retail banks (which is really just lending money to the retail banks).

Of course the central bank could buy real assets like gold bars or houses, but that doesn’t seem to be the current plan. They’d prefer to use the money in a way that will cause it to slosh around the financial system a bit. That will lower lower the interest rates on retail money, and make it easier for banks to lend money to their customers more freely.

Is it a good idea? Quantitative easing was used after the Japanese banking crisis of the 1990s, but didn’t solve the problem. Japan is still in the economic doldrums. And is it really a wise thing to try to solve the problems caused by the bursting of a credit bubble, by attempting to reflate the bubble?

At best this will have little effect, because anyone who can use money for productive purposes is still able to borrow plenty – only speculative uses are currently hard to borrow for. At worst, this will leave so much money sloshing around that when the economy picks up there will be a burst of high inflation.

There is one way in which quantitative easing is not like printing money and throwing it around the street. It’s possible to reverse the easing at any time by selling off the things that were bought. That will raise the cost of new borrowing, making life harder for those with mortgaged property, and making it very expensive for the government to borrow money to fund the debt that is currently increasing rapidly, so it may not be politically acceptable for the easing to be reversed quickly.

So, to answer the original question, quantitative easing is not exactly the same thing as printing money, but it shares most of the same downsides.

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1 Comment

  • fafura says:

    What if government printed the money – avoiding borrowing and paying interest – and if necessary sold securities or raise taxes if too much money was around? Why they don’t do that? How is it different from selling securities outright?

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