Help! What is Quantitative Easing?

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Quantitative easing (QE) is the name given to a three-part monetary policy program implemented by the Bank of Japan (BOJ) from March 2001 to March 2006. At the outset of the program, the BOJ believed that economic conditions warranted monetary easing as drastic as is unlikely to be taken under ordinary circumstances, and therefore made the following changes to its policy strategy:

1. A switch in the operational objective of monetary policy the policy instrument from an overnight interest rate to current account balances(bank reserves plus deposits of non-bank financial intermediaries at the central bank).

2. A reduction in the overnight interest rate to zero.

3. A commitment to maintain the new procedures until y/y CPI inflation registers stably at zero percent or higher.

Virtually all developed-world central banks conduct monetary policy in the same way: by adjusting the supply of bank reserves balances in accounts commercial banks maintain at the central bank in order to target a specific short-term interest rate. The amount of reserves supplied is a passive variable in this process. Banks demand a certain quantity of reserves to meet reserve requirements plus an additional, much smaller, amount of precautionary reserves. The central bank simply meets the amount of reserves demanded at the targeted interest rate. As a result, the total amount of reserves in the banking system is, in a normal environment, very close to the level of required reserves (i.e there are very little excess reserves).

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