Quantitative easing

A monetary operation in which a central bank creates reserves and uses them to buy assets, most often the government's own bonds and in some programmes mortgage backed securities or corporate debt. The purchases are made from banks, funds and other existing holders in the secondary market, and they are announced in advance with a stated size, a stated pace, or both. The reserves created are electronic balances held at the central bank by the banking system, which is why the operation changes the composition of financial assets rather than the notes in anyone's hand.

The instrument exists because the policy rate runs out of room. Once the short rate sits near its floor, further easing has to be applied further along the curve, and buying long dated bonds bids their prices up and their yields down directly. Two other channels are usually described alongside it: sellers who part with bonds hold cash they tend to redeploy into other assets, and a programme announced with a size and a horizon is itself a statement that policy will stay loose, which moves expectations before a single bond is bought. The central bank's balance sheet grows by the amount purchased, with the assets on one side and the new reserves on the other.

Several things are routinely misread. The operation is not government spending and cancels no debt: bonds are bought from holders rather than from the treasury, because direct financing of a government is prohibited under most central bank mandates. The currency effect is the least reliable part of the story, since lower yields are conventionally cited as weakening a currency while an announced programme is frequently priced well before it begins, so a currency can rise on the announcement of one. And the size of the effect is genuinely unsettled among economists: estimates of how far a programme moved long yields vary widely, they disagree about how much of the effect came from the purchases and how much from the signal, and the programmes studied were deployed into market stress, which makes them a poor guide to what an identical operation would do in calm conditions.