Central banks, like the Bank of England, attempt to manage the amount of lending and activity in the economy by altering interest rates.
What is Quantitative Easing?
One option for central banks is to lower the base rate of interest, encouraging people to spend instead of save. When interest rates can’t go any lower, central banks can pump money into the economy directly - this is known as quantitative easing.
Central banks do this by buying assets, often government bonds, using money created from thin air.
Commercial banks or other financial businesses can then sell these bonds and will have more money available to lend, which in turn, boosts the money supply.
How Does Quantitative Easing Work?
When a central bank buys up government bonds, the demand for them increases. Increasing demand for government bonds pushes up their value, making them more expensive to buy.
The expensive government bonds become a less attractive investment; the companies which sell their bonds can now use the proceeds to lend to other companies and individuals.
Banks become more enthusiastic about lending and (in theory at least) the interest rates they charge fall, persuading companies and individuals to spend more.
Central banks hope that the increase in spending, bought about by quantitative easing, boosts the economy.
How Does Quantitative Easing Affect You?
The ultimate aim of quantitative easing is to make borrowing cheaper, reducing the interest rates banks charge on borrowing. In the short term, this may make any new borrowing cheaper; in the long term, the economy should be bolstered.
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