Question

Explain quantitive easing also give an example of why this is a good policy then give an example of why this could be a bad policy

Answer 1

At near zero interest rates, the central bank is left with few policy options. In such a case, it can still undertake quantitative easing. It refers to purchase of financial assets from commercial banks. These financial assets are usually stocks and bonds.

It is a good policy since banks get liquidity from the central bank. The banks can then lend this money to the firms and hence improve overall spending in the economy. Once the spending picks up, the economy begins to recover out of the downturn. This policy worked effectively after subprime crisis of 2008 when US economy did recover from the downturn.

It can be bad policy in the sense that it may result in asset bubble. If banks begin to lend recklessly then it may cause another crisis in the medium-long term. Too much lending can result in bad loans and poor loan quality can result in crisis of another level.