Central banks (such as the Reserve Bank of Australia) typically affect interest rates in an economy by changing the overnight cash rate (the rate used by the banks to lend to one another overnight). This typically has the effect of changing other interest rates in an economy, for example the home loan variable rate.
But what can be done when that overnight cash rate hits zero or near-zero?
This is the point at which central banks can enter into ‘quantitative easing’ (QE).
By its very nature QE is unconventional, as interest rates are at (or approaching) zero; however, the intent is the same as more conventional monetary policy when interest rates are decreasing – increase money supply and stimulate lending and growth in an economy.
Undertaking QE sees the central bank purchasing assets from ‘the market’ in exchange for money and in doing so increase the money supply in ‘the market.’
It’s often referred to as ‘printing money’ but this is not technically correct. In effect, central banks are exchanging the cash in their reserves for markets assets in the hope that the market will distribute the cash (in the form of lending) to stimulate growth in the economy. This is vastly different to the act of printing new money which devalues a country’s currency and causes inflation.
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