The Economist explains: What is quantitative easing?

Posted: January 15, 2014 in economy
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AMERICA’S Federal Reserve surprised markets in December by starting to “taper” its programme of monthly purchases of government and mortgage bonds—a process known as “quantitative easing”, or QE—from $85 billion a month to $75 billion. Some worry that scaling back QE could endanger America’s recovery or create financial instability in emerging markets. Meanwhile, expectations are rising that the European Central Bank may soon launch its own QE programme to boost the euro-area economy, where high unemployment is contributing to deflation. But what exactly is quantitative easing, and how is it supposed to work?Central banks are responsible for keeping inflation in check. Before the financial crisis of 2008-09 they managed that by adjusting the interest rate at which banks borrow overnight. If firms were growing nervous about the future and scaling back on investment, the central bank would reduce the overnight rate. That would reduce banks’ funding costs and encourage them to make more loans, keeping the economy from falling into recession. By contrast, if credit and spending were getting out of hand and inflation was rising then the central bank would raise the interest rate. When the crisis struck, big central banks like the Fed and the Bank of England slashed their overnight interest-rates to boost the economy. But even cutting the rate as far as it could go, to …

via Economic Crisis http://ift.tt/1hV2dre

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