What role does the central bank play in quantitative easing?

The central bank's role in quantitative easing primarily involves managing interest rates through the purchase of assets, which is a tool used to inject liquidity into the economy. When the central bank buys financial assets, such as government bonds, it increases the reserves of the banking system, which lowers interest rates. Lower interest rates make borrowing cheaper for businesses and consumers, encouraging spending and investment.

This approach is particularly important in times of economic downturn when traditional monetary policy, such as adjusting the short-term interest rate, might not be sufficient to stimulate growth—especially when rates are already near zero. By purchasing assets, the central bank can influence long-term interest rates and promote easier financial conditions, ultimately aiming to boost economic activity and support recovery.

In contrast, reducing the money supply would counteract the aims of quantitative easing, while increasing government taxation is not a tool that the central bank uses in this context. Encouraging inflation is not the primary objective, although making borrowing cheaper can lead to increased spending, which might help achieve a targeted inflation rate in a struggling economy. Thus, managing interest rates through asset purchases is a fundamental aspect of how the central bank implements quantitative easing.