The ABC of quantitative easing - Or the basics of central bank asset purchases

The article explains the rationale and transmission mechanisms of a central bank asset purchase programme, with particular focus on the ECB’s own experience. The first part explains how the limits of traditional interest rate policies, in particular the lower bound on nominal interest rates, can complicate the central bank’s steering of longer-term real interest rates and hence jeopardise its primary objective of price stability. The second part explains how asset purchases can help to circumvent that constraint and allow the central bank to continue to steer borrowing conditions in the economy. Asset purchases actually have an impact on financing conditions well beyond the direct effect they exert on the assets bought because expectations regarding the trajectory of policy rates, various risk premia, the exchange rate and inflation expectations are also affected. Asset purchases create base money and also support money creation, even if the latter impact is more indirect. Quantitative easing is a source of revenue for the Eurosystem today but the future trajectory of these revenues depends on future movements of policy rates. Finally, the article explains how maturing bond holdings and a pick-up of nominal economic growth, supported by the asset purchases themselves, are natural mechanisms to exit the regime of abundant central bank liquidity.