How quantitative easing works
QE does not hand anyone money. It swaps bonds for cash, which pushes investors up the risk curve into shares and property.
Understand the mechanism behind the phrase 'money printing', and why it is a poor description.
How quantitative easing works works, in one picture
The same argument as the text, as a chain. Each step is what makes the next one possible.
One number, four consequences
A rate is the price of the future. Move it, and everything whose value sits in the future is repriced, which is why growth companies fall hardest.
- 1
Rates hit zero, and the usual tool runs out
The standard way to support an economy is to cut interest rates. Once they are at zero, you cannot cut much further, so central banks reach for something else.
- 2
The bank creates reserves and buys bonds
It credits itself new money and uses it to buy government bonds from institutions. Notice what has happened: the institution no longer has a bond, it has cash. No new money reached the public. An asset was swapped for a different asset.
- 3
Which forces investors up the risk curve
That institution still needs a return, and the safe asset it used to hold has just been bought out from under it, and bond yields have been pushed down. So it buys something riskier: corporate debt, then shares, then property. Every asset gets bid up in turn.
This is why a decade of QE produced enormous asset inflation and rather little consumer inflation. The money went into markets, not into wages.
- 4
And why unwinding it is so delicate
Reversing the process removes that bid. The buyer of last resort stops buying, and every asset that was priced against a suppressed yield has to be repriced against a real one.
You can explain why QE lifted share prices without directly giving anybody money.
Read next
QE does not hand anyone money. It swaps bonds for cash, which pushes investors up the risk curve into shares and property.
Price to book and return on equity read together, which is the only way a bank makes sense.