Central banks use quantitative easing to lower borrowing costs when short-term policy rates are near zero and traditional tools are exhausted. The policy involves large-scale purchases of government bonds and sometimes other assets, which directly affects yields along the curve and alters expectations about future monetary policy. Empirical studies from major central banks and academic researchers consistently show that QE lowers long-term interest rates, primarily by reducing the compensation investors demand for holding duration and by changing the supply of safe assets available in private portfolios.
Mechanisms that lower long-term rates
The first channel is the portfolio balance effect. When central banks buy long-dated government bonds, they remove duration from private hands, pushing investors toward other assets and lowering term premia. Joseph Gagnon at the Federal Reserve Board documented these market effects following the Federal Reserve's large-scale asset purchases, showing declines in yields consistent with a portfolio rebalancing story. A second channel is signaling: asset purchases communicate commitment to lower short-term rates for longer and to provide monetary stimulus, which reduces expected future short rates and thus long-term yields. Ben Bernanke at the Brookings Institution has emphasized how signaling and term-premium compression work together in the transmission of QE. A third mechanism is liquidity: purchases can improve market functioning and reduce liquidity premia, as described in research by Michael Joyce at the Bank of England examining the Bank of England's asset purchase program.
Wider consequences and regional nuances
Lower long-term interest rates have varied consequences. For households and firms, cheaper long-term borrowing can stimulate mortgage borrowing and corporate investment, supporting consumption and employment. Arvind Krishnamurthy at Stanford University and Annette Vissing-Jorgensen at Northwestern University analyze how changes in the supply of safe assets shift yields and asset prices, affecting risk-taking and balance sheets across the economy. For savers and pension funds, persistently low yields can squeeze income and force a search for yield that raises exposure to riskier assets, with distributional implications that can widen wealth inequality.
Territorially, QE in major economies often produces cross-border capital flows and exchange rate effects that matter for emerging markets. Lower yields in advanced economies can push investors to seek higher returns abroad, appreciating asset prices and complicating monetary and financial conditions in receiving countries. These international spillovers can amplify both financial stability risks and political tensions over currency movements.
Environmentally, lower long-term rates reduce the cost of capital for energy and infrastructure projects, potentially aiding financing for low-carbon investments. At the same time, cheap finance can make carbon-intensive projects more economically attractive in the short run, so the net environmental outcome depends on complementary policies.
In sum, quantitative easing impacts long-term interest rates through several well-documented channels that compress term premia and reshape portfolio allocations. The resulting benefits for aggregate demand and investment coexist with distributional, cross-border, and environmental trade-offs that policymakers must weigh when designing and communicating asset purchase programs.