Money by Magic!!

In the wake of recession, Central Banks around the world are scrambling to increase money supply to boost spending and ease terms of credit. One way is through Borrowings: internal and external but they are weighed down by unwillingness and high terms of credit. Another instrument is Quantitative Easing which literally means reducing the monetary burden by creating more money.



Traditionally, Banks lower interest rates to stimulate economy but with interest rates inching to near zero levels, the method has limited application. Quantitative Easing is a policy where Central Banks purchase government and corporate bonds (issued by Banks), financial assets etc.

As the supply of bonds decrease it increases their price. Consequently, their utility as an attractive investment option shrinks or the yield on bonds diminishes. Hence, the Banks that sold the bonds are flush with excess money and they can lend the money to individuals or businesses as the yield on bonds is lower. This results in greater and easier access to credit and spurs economic activity.
Alternatively, for an economy unilaterally pursuing Quantitative Easing can be negative. For example, for US if too much money is created, it will lead to inflation or even hyperinflation. With rising inflation, investors will search for other financial instruments like gold or other currencies which could weaken dollar.
Quantitative Easing was first used by Central Bank of Japan to counter deflation. Lately, both US and UK have used it vigorously. The Bank of England has announced its intention to increase its exposure to £175 billion of which £125 billion has already been created. Central Banks across the world are taking proactive steps to negate recession, but will they it out to be a magic wand or a hex, can only be conjured.

Contributed By:

Ankit Agarwal