When a crisis hits a nation – or in the case of the Covid-19 pandemic, the entire world – governments and central banks have to act fast.
When the pandemic hit in March 2020 and lockdowns were imposed throughout the world, economies suffered sharp declines.
In response, the US Federal Reserve took a seemingly drastic measure to inflate the economy: they printed trillions of dollars.
The US introduced “quantitative easing” during the pandemic to help keep the economy afloat
The action of printing money in order to help the economy remain buoyant is known as “quantitative easing” (QE). QE was first introduced in March 2009, following the stock market crash of 2008.
The Federal Reserve printed approximately $3.3 trillion in 2020 alone, which, according to City AM, equates to one-fifth of all US dollars in circulation in the same year.
You might be wondering: how can simply printing more money help in a crisis?
In basic terms, the key motivator for QE is to encourage borrowing. Due to the high number of loans available from banks, interest rates usually remain low, meaning borrowing stays cheap.
For example, according to Trading Economics, the Federal Reserve’s “fed funds rate” – an equivalent to the UK’s base rate – dropped from 1% to 0.25% in March 2020.
A 0.25% interest rate afforded individuals the opportunity to borrow as cheaply as possible during the pandemic with the hope that, in turn, they spend this money on goods and services to boost the economy.
This is an example of how QE can benefit the country in the short term – it encourages individuals to continue spending money in an economically precarious time.
While it may have helped stabilise the US economy during the peak of the Covid-19 pandemic, QE has some disadvantages that are now being experienced in 2022.
Quantitative easing can have adverse long-term effects on the economy
Like many things in life, short-term solutions can have some negative ramifications in the long run.
Here are some of the long-term consequences the economy is now experiencing from the Federal Reserve’s 2020 QE strategy.
1. High inflation
Of course, bloating the economy with cash can lead to price rises as there is more demand chasing a limited supply of goods and services. This has caused inflation to reach significant highs.
The inflationary effects of QE are evident in 2022: US inflation reached a 41-year peak of 8.5% in March.
2. Rising interest rates
As inflation rises, interest rates often follow suit, in order to slow consumer spending and protect the economy from the soaring cost of living.
So, while interest rates remained at record lows during the pandemic, they are now steadily increasing again, in order to stabilise the effects of QE on the economy, among other factors. US interest rates stood at 1.5% to 1.75% in June 2022 – up more than 1% from a year ago.
3. Market volatility
Although 2022’s market dip has been caused by multiple factors, such as the Russian invasion of Ukraine, QE can contribute to market volatility too.
By flooding the economy with cash, QE boosts public spending power, and can contribute to share prices rising as a result. However, when inflation begins to rise, and interest rates follow suit, market values can dip again.
Quantitative tightening (QT) or “tapering” QE can help curb the rate of inflation and keep interest rates low
Now that it seems the worst of the Covid-19 pandemic is behind us, the Federal Reserve have begun “tapering” the QE that was introduced in March 2020.
As opposed to “quantitative tightening” (QT), which would involve actively under-printing US dollars in order to make borrowing more expensive and slow the rate of inflation, the Federal Reserve is simply tapering the printing of the dollar over time.
This gradual approach could be being employed in order to minimise the long-term effects of QE, and to keep interest rates, and markets, steady during an already uncertain time.
The UK adopted a similar QE approach during the Covid-19 crisis
Alongside the US’s QE strategy rolled out in March 2020, the UK adopted a similar approach during the pandemic.
For example, according to Statista, the UK’s furlough scheme cost the UK government around £70 billion. The scheme propped up businesses and kept employees financially viable when they were unable to continue working.
Similarly, the Commons Library claims that the government’s “Eat Out To Help Out” scheme cost £849 million. “Eat Out To Help Out” provided a 50% discount for individuals eating at restaurants and cafes between 3 and 31 August 2021.
Both these economy-boosting measures could be seen as a smaller-scale QE rollout that encouraged public spending during the Covid-19 pandemic.
However, just like in the US, the UK is experiencing the full effects of QE this year. In an even steeper trajectory to that of the US, UK inflation has now reached 9% in May 2022.
Of course, there are other global factors contributing to inflation and rising interest. Nevertheless, in part, the soaring price rises Brits are experiencing could be attributed to the QE strategies employed by the government during the pandemic.
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The effects of QE are still being felt by individuals in the UK and the US.
If you are concerned about how rising interest rates might affect your wealth this year, for example, you can read our insights on rising interest rates [NP1] or contact us directly.
For any other financial guidance, email email@example.com or call 0161 8080200.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.