Monetary Policy: Quantitative Easing and Money Supply

When interest rates approach the zero lower bound, central banks turn to unconventional monetary policy tools. The most significant of these is quantitative easing (QE) — a policy that became a central feature of UK macroeconomic management after 2009. Understanding how QE works, its intended effects, and its limitations is essential for A-Level Economics.

Key Definition: Quantitative easing (QE) is a form of unconventional monetary policy in which the central bank creates new electronic money to purchase financial assets — primarily government bonds (gilts) — from the private sector, in order to increase the money supply and stimulate economic activity.

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The Money Supply

Before examining QE, it is important to understand what the money supply is and why it matters.

Definitions of Money

Money serves four functions: a medium of exchange, a store of value, a unit of account, and a standard of deferred payment. The money supply is measured in different ways depending on which assets are included: