Quantitative easing (QE) is a central bank policy of purchasing substantial quantities of assets, usually longer-term bonds, with newly created central-bank money to ease financial conditions. It can reach beyond the overnight policy rate, particularly when that rate is near its effective lower bound. For a quant, the important distinction is between the settlement transaction and the uncertain effect on yields, credit and spending. RBA explainer.
An asset purchase is not automatically QE
Open market operations include securities purchases and sales for several purposes. Routine reserve management can support overnight rate control; QE deliberately uses a large purchase programme to ease broader financial conditions, often through longer maturities. The transaction type alone does not establish the policy's purpose. Read the mandate, asset eligibility, maturity range and announced purchase amount or pace. Federal Reserve overview.
Follow both balance sheets
Suppose a central bank buys 10 million currency units of existing government securities directly from a commercial bank's own portfolio. The purchase price equals the bank's carrying value; ignore fees, income and other transactions. Settlement creates reserves, which are the bank's asset and the central bank's liability.
| Account | Central bank: change | Selling bank: change |
|---|---|---|
| Securities assets | +10 | −10 |
| Reserve assets | — | +10 |
| Reserve liabilities | +10 | — |
| Customer-deposit liabilities | — | 0 |
| Total assets | +10 | 0 |
| Equity | 0 | 0 |
All amounts are millions of currency units; a dash means the account is not relevant to that column. Both entities satisfy : assets change by the change in liabilities plus equity. The central bank expands; the seller exchanges one asset for another. This settlement creates no new customer deposit or loan in the bank-seller example. New York Fed balance-sheet explanation.
Fictional transaction; changes in millions of currency units. The bank sells its own securities at carrying value. Accounting entries are certain under these assumptions; subsequent portfolio, lending and spending responses are conditional.
The seller matters. If a nonbank investor sells instead, its bank normally receives the reserves and credits the investor's deposit account. That creates a deposit as part of settlement, but still does not mean a new bank loan or purchase of goods occurred. The New York Fed explains these distinct entries. Reserves are not mechanically multiplied into lending; credit decisions and economic responses require more than the reserve entry. Bank of England money-creation explanation.
Why buying longer bonds can matter
QE can affect yields through several channels:
- Portfolio balance. Removing longer bonds from private portfolios may encourage purchases of substitute assets. Higher prices mean lower yields. This can compress the term premium, the compensation in a long yield beyond expected future short rates.
- Signalling. Announcements may change expectations of future policy rates, another component of long yields.
- Market functioning. Purchases during stress can improve trading conditions and reduce liquidity premia.
Their importance varies across episodes. Purchase amounts do not imply fixed changes in lending, output or inflation. See the Bank of England's review of QE theory and evidence.
Reading QE as a market signal
Track announcement surprises, expected holdings and maturity exposure as well as purchase flows. Anticipated purchases can be priced before settlement. An announcement may also reveal economic news and policy-rate expectations: a coincident yield move is not automatically a causal QE estimate. These are practical implications of the identification problems in the Bank of England review.
Sources
- Reserve Bank of Australia: Unconventional Monetary Policy — Asset purchases.
- Federal Reserve: Open Market Operations.
- Federal Reserve Bank of New York: How the Fed Changes the Size of Its Balance Sheet — Asset Purchases.
- Bank of England: Money creation in the modern economy.
- Bank of England: QE at the Bank of England — theory and evidence.