Explainer - How does Quantitative Easing work?
Monetary policy generally operates by steering short-term interest rates, reducing them when inflation and economic growth are too low, and raising them when inflation and economic growth are too high. However, reducing rates much below zero is difficult. Therefore, during times of persistently low economic growth and inflation, it might not be possible to reduce interest rates.
At times like these, to help stimulate the economy, central banks use Quantitative Easing, a tool that in the euro area is called the Asset Purchase Programme (APP). The APP was initiated in October 2014 to support the monetary policy transmission mechanism and provide the amount of policy accommodation needed to ensure price stability.
When the Eurosystem purchase financial assets under APP, the increased demand for these assets drives up their prices. As a result, market interest rates decline which also ultimately passes through to bank lending rates. As a result, these programmes make it easier to access credit, not only for asset issuers (governments, companies and banks), but also for those agents more reliant on bank lending, such as households and SMEs. Therefore, these programmes stimulate consumption and investment. The APP consisted of public sector debt securities (through the PSPP), corporate bonds (CSPP), asset-backed securities (ABSPP) and covered bonds (CBPP).
Over the years, the ECB’s Governing Council has taken several decisions to recalibrate the pace of purchases and reinvestments, and net asset purchases were discontinued at the end of June 2022. In June 2023, it was decided to discontinue reinvestments under the APP as of July 2023. The APP portfolio will decrease over time as assets reach maturity unless the Governing Council decides, as appropriate, to use this instrument to steer the ECB’s monetary policy.
In addition, the ECB’s pandemic emergency purchase programme (PEPP) is a non-standard monetary policy measure initiated in March 2020 to counter the serious risks to the monetary policy transmission mechanism and the outlook for the euro area posed by the coronavirus (COVID-19) outbreak. Net asset purchases were discontinued at the end of March 2022 and reinvestments under the PEPP were discontinued at the end of 2024.
Following the financial crisis of 2008-2009 and the COVID-19 outbreak, large central banks like the USA’s Federal Reserve and the Bank of England also began asset purchase programmes in an effort to stimulate economic growth.
As part of the ECB’s monetary policy strategy review, concluded in July 2021, the Governing Council recognised that, while its policy rates remain the primary monetary policy instrument, in the presence of an effective lower bound on policy rates, it will employ asset purchases as appropriate.
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