Quantitative Easing and Tapering

At times of low economic growth, the central bank is tasked with stimulating the economy. Usually the

central bank lowers the interest rate at which it lends to other banks who in turn lend at cheaper rates to

normal people. This cheap money is expected to drive demand leading to money whizzing around leading

to healthier economy. But the problem comes when this fails to work. What can the government do if the

interest rates are near zero? They surely can’t go below zero, can they?

This calls for unconventional measures to stimulate the economy. In the aftermath of recession, this is

precisely what happened in the US. The interest rates approached zero, but the economic activity was still

below average. The Federal Reserve chairman Ben Bernanke came up with the idea of quantitative

easing. What it means is the fed will buy assets from other banks and entities. These assets could be

mortgage backed securities, government bonds etc. So the price of bonds goes up and yield goes down.

This fuels the money available for commercial banks who in turn will lend to normal people with

increased enthusiasm. It creates a ripple effect with more money flowing around and helping the


It was tried first by a central bank in Japan to get it out of a period of deflation following its asset bubble

collapse in the 1990. In the US, the Federal Reserve has gone through three rounds of quantitative easing

to help stimulate the economy since November 2008. This increased the size of the Federal Reserve's

balance sheet—the value of the assets it holds—from less than $1 trillion in 2007 to more than $4 trillion


As expected, it led to improve in economic activity in the US. During the easing, there was an inflow of

money into emerging economies like India where there are more attractive investments. Therefore, the

Foreign Institutional investments soared in India.

However there were concerns about...