The European Central Bank introduced a new round of quantitative easing (QE) in March 2020, purchasing up to €750 billion of assets - Edexcel - A-Level Economics A - Question 7 - 2021 - Paper 2

Introduction

Quantitative easing (QE) is a monetary policy tool wherein a central bank purchases financial assets to inject liquidity into the economy. The European Central Bank (ECB) introduced QE in response to the significant recession posed by the COVID-19 pandemic.

Arguments that QE has been effective

1. Increased Lending to Businesses
   QE provided financial institutions with additional funding, allowing them to increase lending to businesses. This led to increased investment and, consequently, economic growth. With businesses receiving necessary capital, they could maintain operations and retain employees, thus stimulating the economy.

2. Increased Consumer Spending
   Similarly, by increasing funding to financial institutions, QE permitted them to extend more loans to consumers. This expansion in consumer credit helped boost consumption in the economy, which is crucial for economic recovery during a recession.

3. Prevention of Deflation
   Without QE, it’s possible that the Eurozone could have experienced deflation. By injecting liquidity, the ECB aimed to counteract potential deflationary pressures and support price stability.

4. Monetary Policy Response
   QE acted as a critical monetary policy tool for the ECB, particularly after traditional measures like lowering interest rates were fully utilized. This served to reassure markets and stabilize expectations regarding economic recovery.

Arguments that QE has not been effective

1. Lack of Confidence
   Many financial institutions were hesitant to use the funds provided through QE due to a prevailing lack of consumer and business confidence. This meant that even with increased funding, there was insufficient demand for loans.

2. Increased Savings Rates
   During the recession, consumers and firms preferred to save rather than spend or invest, limiting the potential effectiveness of QE. The precautionary saving increased as uncertainties loomed over the economy.

3. Limitations of Fiscal Policy
   Many European countries implemented contractionary fiscal policies during the recession, which countered the effects of QE. As a result, the overall impact of QE was diminished as public expenditure did not accompany the monetary stimulus.

4. Inflation Risks
   There are concerns that if the economy rebounded too quickly due to excessive liquidity, it could lead to inflationary pressures. The differing economic conditions across EU nations meant that the effects of QE were uneven, with some countries facing inflation risks while others struggled with stagnation.

Conclusion

In conclusion, while quantitative easing has had beneficial effects by stabilizing financial markets and supporting economic activity, its effectiveness has been hampered by issues such as lack of consumer confidence, increased savings, fiscal policies, and potential inflation risks. Therefore, its success during a significant recession remains mixed.