THE SENIOR ANALYST
Quantitative Easing
Tapering and its impact
on the Indian Economy
What is quantitative easing?
Usually, all central banks use officially set interest
rates for proper regulation of economy. These
rates are radiated out to the rest of the economy
while lending and paying back of loans,
mortgaging of assets or return on the money
assigned for savings. But when the interest rates
reach sky high, borrowing of loans become
difficult and the ability to spend decreases thus,
attracting saving and decreasing demand. Lower
interest rates have an opposite effect.
But interest rates cannot go below zero as the
effect on the economy will go down thus, slowing
the growth of the country. When economic
growth slows down and the interest rates begin
to approach zero, the central bank uses the open
market operation of Quantitative Easing to ease
down the situation by pumping in money into the
economy. The money is not directly infused or in
other words, there is no direct printing of
currency notes. It is done rather electronically.
The central bank buys assets more commonly in
the form of government bonds, equities or
corporate bonds from commercial banks or other
financing companies. This encourages banks and
other financial services companies to lend bonds.
The interest rates keep changing depending on
the purchases made on assets.
Thus, the price of the assets bought by the
central bank increase and the interest rate falls.
With the help of easy and cheap borrowing due
to lower yields, the central bank is able to
increase spending power of common people and
thus, create more demand pulling the economy
out of recession. Consumers spend and borrow
more money which in turn stimulates the
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economy. Now there is greater demand for goods
and services, employment rate increases and the
amount of disposable income in the hands of the
common people also increases. This also keeps a
check on inflation and the inflation rate is under
control.
Moreover, the currency of the home country
depreciates due to quantitative easing. The lower
interest rates attract domestic investors to
engage in investing activities. This money can
further be invested overseas. The cheaper
currency in turn stimulates foreign trade as well.
Risk associated with QE
The money generation effects of quantitative
easing are not as rosy as they seem. Rather, the
risk associated with QE keep increasing with the
increase in money infusion. There are many risks
that could be of concern to various investors and
policy makers.
Due to ease in the economic scenario, more
money circulates in the country which increases
the demand. This increase in demand increases
the spending capacity of people which has direct
upward effect on the price level of everyday
co