As the global economy continues to evolve in the post pandemic world, there has been much debate about the appropriate monetary policy tools at the disposal of the Federal Reserve and Central Banks around the world to ensure economic stability.
Two such tools are quantitative easing (QE) and quantitative tightening (QT), which are used by central banks to manage the money supply and interest rates. In this post, I will discuss the differences between QE and QT.
Quantitative easing is a monetary policy tool used by central banks to stimulate economic growth. It involves the purchase of government bonds and other securities by the central bank, which increases the money supply and lowers interest rates. This, in turn, encourages borrowing and spending, which can stimulate economic growth.
QE was used largely during the COVID-19 pandemic to foster expenditure and avoid recession.
Quantitative tightening, on the other hand, is the opposite of QE. It involves the sale of government bonds and other securities by the central bank, which reduces the money supply and raises interest rates. This, in turn, can slow down economic growth by making borrowing and spending more expensive.
As we know from the Media and press releases from the Fed Reserve officials, inflation has been running loose for a few months as a result of the large Monetary base available in the economy without a due counterpart in increased goods and services during the same period of time.
The decision to implement QE or QT is based on the economic conditions at the time. If the economy is in a recession or experiencing slow growth, central banks may use QE to stimulate borrowing and spending. Conversely, if inflation is high or the economy is overheating, central banks may use QT to cool down the economy and prevent inflation from rising too much. This is why the Fed Reserve and Central Banks around the world have been rising interest rates across the board.
It’s worth noting that QT can have unintended consequences such as tightening of credit conditions, which can make it difficult for businesses (including Banks) and individuals to access credit.
Still is not clear as to which direction the Fed Reserve is going to take during March but what is true is that the fragility of the global banking system itself is sending a clear signal to the Central Banks that they might have gone too far in raising interest rates in their quest to control inflation.