QE Can Lower Rates Today and Still Weaken Debt Sustainability

Quantitative easing is usually discussed as a way for central banks to support the economy. When financial markets are under stress or the economy is weak, the central bank buys government bonds and other assets. Those purchases can lower long-term interest rates, support asset prices, and make borrowing easier.

But there is a harder question behind the short-run effect: what does QE do to government debt sustainability over time?

My research with Sebastian Merkel studies that question. The conventional view is that QE improves fiscal space because it lowers the interest rate the government pays on its debt. That view is intuitive, and it captures one important part of the mechanism.

Our argument is that it misses another part. QE does not only lower yields. It also uses central bank capacity. When the central bank buys large amounts of government debt, it changes the consolidated public balance sheet. It may reduce the amount of debt private markets need to absorb today, but it can also reduce the central bank's future ability to support the fiscal authority and stabilize markets in a crisis.

The simple way to put it is this: QE can make debt look safer today while making the system more fragile tomorrow.

To see why, think of the central bank as having a form of long-term capital. This capital is not just an accounting line on a balance sheet. It includes the central bank's ability to generate remittances for the Treasury, its credibility, and its capacity to stabilize markets. These resources are finite. Using them today leaves less available later.

That distinction is important because debt sustainability is not only about the interest rate this year. It is about whether the government can continue financing itself when conditions become difficult. A government can look comfortable when rates are low, but if those low rates are maintained by drawing down central bank capacity, the apparent comfort may be temporary.

In our framework, QE has two opposing effects. First, it reduces the amount of government debt that private investors must hold. That pushes up bond prices and lowers yields.

Second, QE depletes central bank capital. It reduces future remittances or fiscal resources flowing from the central bank to the government, and it lowers the support the central bank can provide in a future debt-market crisis. QE may lower the government's financing cost today, but it can shrink the safety buffer that protects the government tomorrow.

This produces a sharp policy lesson. Low interest rates under QE are not automatically evidence that debt is sustainable. They may instead reflect active intervention that is costly to maintain. If keeping rates low requires an ever-larger central bank footprint, the system can become dependent on continued support.

That is why balance-sheet policy can create an uncomfortable dynamic. QE suppresses rates, which can make higher debt appear manageable. Higher debt then makes it more tempting to continue QE or delay balance-sheet reduction. But continued QE uses more central bank capacity.

This is not an argument that QE should never be used. In a crisis, central bank intervention can be essential. The March 2020 dash for cash showed that even the Treasury market can come under severe strain.

The point is that QE should not be treated as free fiscal space. It is a policy that shifts risks across time. It can relieve pressure today while increasing vulnerability later. A responsible policy debate should weigh both sides.

This also changes how we should interpret the post-2008 era. Many advanced economies experienced both large increases in central bank balance sheets and large increases in government debt. Because interest rates stayed low for a long time, it was tempting to conclude that debt capacity had permanently expanded. Some of that may be true. But some low rates may also have reflected sustained central bank intervention. If so, the low-rate environment came with a balance-sheet cost.

The issue has become more visible as central banks try to shrink their balance sheets. Quantitative tightening is politically and financially harder when governments have become accustomed to low borrowing costs and markets have become accustomed to central bank support. This difficulty is itself part of the message. If QE were purely a free improvement in fiscal conditions, exiting it would be easy. The fact that exit is hard suggests that QE creates dependence.

For the public, the most important takeaway is that government debt cannot be judged only by today's interest rate. A low rate is helpful, but we also need to ask why the rate is low and what resources are being used to keep it low.

For policymakers, the implication is not to abandon QE, but to use it with a clearer budget. QE should be evaluated like any powerful public intervention: what is the immediate benefit, what capacity does it consume, and what happens if the economy needs that capacity later?

The central bank's balance sheet is not just a technical monetary-policy tool. It is part of the fiscal architecture of the state. It affects who holds government debt, how much private markets must absorb, how much income flows back to the Treasury, and how much room the central bank has in future crises.

QE can be necessary. It can be effective. But it is not magic. If it lowers yields by spending scarce central bank capacity, then the short-run gain comes with a long-run cost.

The right lesson is not panic. It is discipline. Central banks should preserve the ability to act in crises, governments should not treat QE as a substitute for fiscal capacity, and markets should remember that low yields are not always the same thing as low risk.