A note on Qualitative easing

While the concept of quantitative easing has received a lot of attention amongst economists, qualitative easing was not as widely discussed. Qualitative easing is a monetary easing program that was used by Japan in 2013 and represents some elements of the QE programmes in the US. 

The outline of how it works is well described here, and so I want to focus a little bit more on why.

When interest rates hit the zero lower bound, a potential goal of a central bank is to increase liquidity to give a push to inflation. The standard approach (quantitative easing) is to purchase illiquid assets with liquid currency – where the quality of the assets they will purchase is fixed.

However, there is a spectrum of illiquid assets, with different risk profiles and costs of liquidating.

Qualitative easing is where the central bank accepts either “more risky” or “more illiquid” assets when it purchases assets – changing the composition of its own balance sheet.

If they are solely “more illiquid” then it doesn’t matter – the central bank is infinitely lived and will be able to realise the assets value. If it is “more risky” then there is a potential cost.

The qualitative element is not about increasing the amount of assets, it is about changing the composition – with the purchase of more illiquid assets potentially offering a more effective channel to increase demand.

When to launch qualitative easing?

The central bank can usually just purchases top quality government bonds to do its liquidity injections

If the yield on those goes to zero, or they start to be seen as perfect substitutes for cash, then suddenly you can’t increase liquidity by purchasing those.

So you start looking at other assets that still have a positive yield – or areas where the asset isn’t seen as a perfect substitute for cash.

By doing this, the central bank can boost liquidity and demand through asset purchases.

Qualitative easing then makes sense if:

1. There are greater concerns about the growing “quantity” of assets owned rather than their “quality”.
2. The assets purchased are seen as illiquid but, at least when pooled, are not viewed as risky.