Bubbles do not only appear in financial markets, the word can also be used in a more broader context to describe societal phenomena. It is fair to say that the German media and German politicians, for example, have lived in a bubble of their own since the beginning of the financial crisis. The culprits as well as the solutions to the current stagnation in Europe are usually identified in Germany as follows: Southern Europeans lived for years beyond their means and now have to make up for their past excesses with higher savings and adopting a "protestant work ethic" in the Weberian sense, never mind that the rest of the world actually sees the Eurocrisis from a totally different angle, which actually puts a lot of blame on the German government. There is no doubt about the fact that the austerity policies promoted by the Merkel/Schäuble government have done significant harm to Southern Europe. The IMF has estimated that multipliers were far in excess of 1. meaning that with every euro saved in government spending GDP contracted in excess of 2 euro. Under such circumstances, debt to GDP ratios exploded for many Eurozone countries. Ironically, higher government spending would have led to a lower debt trajectory in the long-run. Of course, all of this was well predicted in advance by Keynesian economists like Paul Krugman and Brad DeLong.
Another common myth widespread in Germany is that Draghi and the ECB are disappropriating the German saver with their low-interest rate policy. This is, of course, nonsense. First, monetary policy accommodation has helped the real economy and supported asset prices in recent years. Second, Central Banks have little influence over the real interest rates. Global real interest rates have declined from a high of about 4% in the early 90s to a low of almost 0% nowadays. This trend is related to a number of structural factors (demographics, innovation, investment and savings behavior) that Central Banks have no influence over. In fact, Germany is one of the main culprits of the current low-interest rate environment. With a current account surplus of about 9% of GDP the country is now a net exporter of about 300 billion USD to the rest of the world during a time when there is already an excess of desired savings over desired investments on a global level. Finally, Germany has continuously called for a more contractionary stance of monetary policy in recent years, never mind the fact that the Eurozone finally started to recover after the ECB under Mario Draghi started its program of asset purchases (Quantitative Easing) in 2014, a full 6 years after the beginning of the financial crisis.
In order to grasp the rational for Q.E., one must understand the nature of a recession. Most economic downturns in advanced economies are the result of an excess demand for the medium of exchange (money) and/or some other safe financial assets (commonly government bonds). One individual can increase its stock of money by reducing the outflow, i.e. reduce spending for goods and services. For society as a whole, however, the fallacy of composition kicks in. As everybody tries to increase its stock of money by reducing purchases of goods and services, the economy contracts as incomes fall in line with reductions in expenditures. A Central Bank can prevent this vicious circle by printing base money so that individuals can increase their money balances up to the point until they demand is satisfied. Any additional increase in the moneys stock will then lead to higher expenditures as individuals try to get rid of their excess money balances. What is true for one individual is not true for the aggregate. While I can increase my money outflow, society as a whole cannot get rid of the additional base money issued by the Central Bank. The money is passed around in exchange for goods and services and output and inflation increase as a result, the split between the two being determined by how far the economy operates from potential output and the slope for the short-run aggregate supply curve.
Besides asset purchases as a means of increasing base money, Central Banks also commonly act as a lender of last resort during times of crisis. The central idea is, of course, that the financial system is crucial to the functioning of the economy. Consumers and firms rely on a well-functioning financial system not only for credit but also for cash flow management. A financial panic can lead to asset price crashes and the freezing of credit markets, which are crucial for the economy. This is exactly what happened in 2008 when the interbank market completely froze up. Banks did not extend credit anymore because counterparty risk is simply too great in times of radical uncertainty. Instead, every bank tried to build up its individual capital buffer in the face of a massive disruptive shock to the system.
The Central Bank can step in during times of crisis and put a floor on asset prices by acting as a buyer of last resort. Furthermore, Central Banks can extend credit lines against collateral when markets are frozen. Of all of this was, of course, already well-understood even during the 19th century. Walter Bagehot explained in his famous 1873 classic "Lombard Street: A description of money markets" how the Bank of England acted as a lender of last resort during the financial panic of 1825. It appears that the crisis cannot be traced back to a single exogenus shock. Suffice it to say that financial markets were already quite integrated back then. Rapid economic expansion int he new world, especially Latin America, was backed up by speculative finance in bond and stock markets. There was a turning point in financial markets in 1825, which resulted in a full-blown financial panic. The Bank of England, timid at first, stepped in as lender of last resort and backstopped the financial system. In the words of the Bank of England director Jeremiah Harman:
"We lent . . . by every means possible and in modes we had never adopted before; we took stock on security, purchased Exchequer bills, we made advances on Exchequer bills, we not only discounted outright, but we made advances on deposits of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the bank ..."
Purchasing government bonds, extending credit lines against collateral, this is nothing else than Quantitative Easing combined with emergency lending facilities. In other words, what Central Banks did in response to the financial crisis of 2008 was far from novel. These policies were first tried by the Bank of England as early as 1825. The backstop of the financial system halted the panic back then and supported the real economy. It is almost certain that the economic recession would have been much deeper and more prolonged without the intervention of the Bank of England.
See Brad DeLong for more: http://theweek.com/articles/506607/panic-1825
Quantitative Easing is thus simply a new word for an old policy, the purchase of financial assets by the Central Bank to back up the economy. So all the people who decried the Fed's actions in recent years because they were "novel", "untested", "never tried before", I guess they would have been right had they been living in London in 1825. The United States' economy has fared much better in the aftermath of the financial crisis of 2008 because the Fed acted relatively aggressively whereas the ECB was far too timid at first. Of course, it didn't help that the ECB was under constant scrutiny from the German government with Schäuble in the driver seat. After the Fed implemented QE2, he called the decision as "clueless". This is pretty rich given that the Fed's former governor Ben Bernanke is one of the most renown monetary economists in the world. I guess that is what you get if you appoint a lawyer as minister of finance. The Eurozone would have done much better had more competent people been in charge in Germany. Maybe, just maybe, let economists be in charge of economic policy? Crazy idea, I know. While we don't have a perfect understanding of the economy, we do have an advantage over non-economists, especially when it comes to tricky things like monetary policy.