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QE Quantitative Easing; Will QE ‘work’? Morgan Stanley Global Economic Forum

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Defining quantitative easing. Quantitative Easing (QE) is in operation when the central bank allows or indeed pursues a rapid expansion of the monetary base.

The mechanics. The monetary base is the sum of currency in circulation and reserve balances of commercial banks (the balances that commercial banks maintain with the central bank). Suppose the central bank lends the commercial bank electronic cash (i.e., simply adds the amount to the credit balance of the commercial bank held at the Fed) in return for a financial security as collateral. The collateral security sits on the asset side of the central bank’s balance sheet, and the central bank credits the reserve balance of the commercial bank, which sits on the liability side of the central bank’s balance sheet, with (electronic) cash. Under normal circumstances, if the increase in reserve balances (and hence the monetary base) is unwelcome, the central bank would simply sell some securities in the open market to reduce the cash balances of commercial banks – an operation known as ‘sterilization’. Effectively, the central bank replaces the security previously held by banks with either cash or with a safe, liquid government security if the first transaction is sterilized. Under quantitative easing, however, the central bank would conduct the first transaction without sterilizing it, thus allowing the reserve balance of the commercial bank, and therefore the monetary base, to expand.




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