We have heard Quantitative Easing (QE for short) mentioned in reports, the media and even speeches by financial leaders. This is an important process conducted by central banks and often impacts the currency of the target economy. Forex is centered around the trading of currencies and hence a good understanding of this concept may bring about better analysis and planning of your trades.
What is Quantitative Easing?
Quantitative Easing is the process of increasing the supply of money in an economy and usually conducted by central banks.
Why conduct Quantitative Easing?
Quantitative Easing is usually conducted when there is a shortage of liquidity in an economy. This is a dangerous situation as growth and financial processes may grind to a halt. For example, new businesses may not get loans due to the risk aversion of banks. It is often a policy of last resort after usual ways to control the money supply such as interest rates have failed. For example during the financial crisis of 2008, the credit crunch of the financial market prompted the US Federal Reserve to implement QE.
How is Quantitative Easing done?
Money is created electronically and mass purchases of bonds, etc are conducted.
As a result of these purchases, banks, investment firms, etc receives a boost to their money supply. This tends to improve liquidity and stimulate lending activities.
With the increase in lending activities, businesses receive the needed funds to conduct economic activities. This stimulates the target economy as the benefits flow downstream, reaching the consumers eventually.
Risk and Impact of Quantitative Easing
Due to the artificial increase of the money supply, inflation may increase and the target economy’s currency may be diluted. This may result in the fall of the currency’s value. Foreign investments may reduce due to the perceived drop in the country’s credit worthiness.
The Bottom Line
There are many variants of the Quantitative Easing process but the general means of how it is conducted and the impact is largely similar. This process is usually conducted over a period of time and has the potential to induce medium to long term trends in the affected currency pairs. Therefore it is crucial that one is aware of developments in this aspect.