The Impact of Quantitative Easing in the United States - Essay Example

? GLOBAL ECONOMY by 16 January Global Economy Discuss the impact of ‘quantitative easing’ in the United s on both the domestic economy of the US and the global economy. The word combination “quantitative easing” has already become the definite feature of the contemporary economic reality. Quantitative easing seems to have become the measure of last resort, when countries, including the biggest powers, are no longer capable of restraining the rapid expansion of the financial and economic crisis. Whether quantitative easing is an effective measure of stopping deflation and encouraging lending is difficult to define. Nevertheless, the end of 2010 was marked with the U.S.’s decision to throw additional money into the domestic economy, to encourage economic growth and slow down the economic downturn. Controversial and radical, the decision to apply to quantitative easing became one of the most actively discussed issues in economics. That quantitative easing has far-reaching implications for the domestic and global economy cannot be denied, but its role in the development and expansion of the positive economic growth is yet to be defined. At the end of 2010, the Central Bank of America announced its decision to pump up additional $600bn into the domestic economy (Elliott & Inman 2010). The decision to use quantitative easing mechanisms was justified by the failure of the American federal authorities and the Fed to accelerate economic growth, encourage lending, and reduce unemployment (Elliott & Inman 2010). It should be noted, that the past recession became the worst economic downturn in America and the rest of the world since the Great Depression (Elliott & Inman 2010). As a result, traditional instruments of economic recovery failed to improve the situation. Quantitative decision for the U.S. was similar to the instrument of last resort, when there is nothing else the Fed can do to alleviate the burden of economic problems within the country. As part of its strategy, the Fed would purchase long-term Treasury bills every month, until the middle of the year, totaling to $75bn (Elliott & Inman 2010). The United States claims that quantitative easing is simply inevitable, when the state wants to preserve “ultra-low” interest rates for an extended period, thus keeping the amount of the borrowing costs unchanged for at least two years (Elliott & Inman 2010). The principal intentions of quantitative easing are but positive. The reality, however, is not as bright as economic theory tries to create it. Even if quantitative easing has a potential to support relative stability in the U.S., it may have damaging and even fracturing effects on the global economy. It should be noted, that economic theory treats quantitative easing as “the central bank’s asset purchases that are designed to inject money directly into the economy to raise asset prices, boost spending and so keep inflation on track to meet the 2% target” (Ganley 2010). The most probable sources of additional assets for the Central Bank include “insurance companies, banks and non-financial institutions, pension funds and firms” (Ganley 2010). Such injections directly into the economy are justified by the rapid contractions in the amount of spending that follow global financial crises (Ganley 2010). More often than not, quantitative easing is used to stop price deflation and encourage real output (Ganley 2010). The history of quantitative easing dates back to the beginning of the 1990s, when Japan found itself in the midst of a deep economic and financial crisis (Kurihara 2006). “The development and implementation of the zero interest policy had to encourage economic recovery but did not produce any real effect on the economic development in the country” (Kurihara 2006). Quantitative easing was introduced to initiate long-term economic growth in Japan. Unfortunately, and after so many years of economic recovery and growth in Japan, whether quantitative easing works remains unclear. There is no definite consensus on whether quantitative easing was the key reason of Japan’s economic recovery (Kurihara 2006). The introduction of quantitative easing by the United States does not help to resolve this controversy but, on the contrary, poses a question of how quantitative easing is likely to affect domestic and global economic processes. “From the standpoint of the domestic economy, the effects of quantitative easing on the U.S. have not been uniform” (Benati 2005). To a large extent, the ambiguity and complexity of quantitative easing in the U.S. have much to do with the circular flow of income, which means that in an economy, income usually flows from one element of the economy to another: spending generates income, whereas new income generates further spending (Benati 2005). Any injections into the economy change the circle of dependencies between income and spending: an injection will necessarily increase the flow of income (Benati 2005). In the United States the first injections resulted in slight disappointment with the amount of money to be pumped into the economy: markets anticipated at least $1tn to enter the economy, and $600bn may not be enough to cope with the current economic pressures (Elliott & Inman 2010). As a result, 20 minutes following the Fed’s “quantitative easing” announcement, the Dow Jones index fell by 50 points and the price of oil jumped to unprecedented $85, reflecting a public belief that excessive liquidity would discourage investors from purchasing government bonds and speculating commodity prices, to stop deflation (Elliott & Inman 2010). Unfortunately, the deeper the U.S. sinks into the recession the more dangerous quantitative easing becomes. The long-term effects of quantitative easing for the American economy are not difficult to predict. Quantitative easing will necessitate further deficits and bailouts in the U.S. (Anonymous 2010). Such an attack on deflation will be necessarily be followed by rapid inflation, as long as the latter exemplifies one of the net effects of quantitative easing (Anonymous 2010). In its current state, the United States lives with confidence that inflation is the lesser of the two evils (Anonymous 2010). Therefore, inflation is not considered as a serious threat to the future economic prosperity and growth in the country. On the contrary, the U.S. applies to a variety of methods and instruments to encourage inflation which can be extremely debilitating for the economy as a whole and the U.S. dollar, in particular. These effects seem extremely desirable within the American economy but can be extremely damaging to the global economy. Inflation will devalue the U.S. dollar, speeding up the velocity of money within the United States and, simultaneously, reducing the monetary value of the economic cooperation between the United States and its economic allies (Benford et al 2009; King 2002). Competitive devaluation of the world currencies exemplifies a zero-sum game, in which American banking institutions and the American economy in total win for the expense of foreign countries, which will subsequently lose in exports profits and revenues. The destruction of the stability of global currency is inherently damaging to the current system of trade relationships between the states, and will result in a serious fracturing of the global economy (Meltzer 2001). Currency differences and their implications for the global economic future cannot be neglected. The decision to implement quantitative easing strategies in the U.S. is likely “to be supported by the Bank of Japan and the Bank of England” (Anonymous 2010). However, the participants of the single Eurozone and the European Central Bank are willing to put off their quantitative easing decisions (Anonymous 2010). As a result, a conflict of the currency interests between the United States and the Eurozone will pose a major threat to the economic stability of other major European states. Today, America again reminds the world of its destructive economic potential. Quantitative easing is likely to become a serious factor of economic instability in the emerging and developing states, which suffer from inflation and lack resources to cope with it (Fujiki & Shiratsuka 2002). The material and economic circumstances in the developing countries do not leave any room for further devaluation of their currency relations with the U.S. Increased liquidity of the U.S. dollar and the subsequent decrease in its value will automatically transfer excessive equity to emerging economies in short-term perspectives (Meltzer 2001). Simultaneously, emerging economies have a potential to reduce the negative implications of quantitative easing by the U.S. The extent to which emerging economies suffer the consequences of quantitative easing will depend on the quality and efficiency of their currency exchange policies (Meltzer 2001). In the long-term periods, quantitative easing can lead to excessive inflow of capital to emerging economies, which can become an extremely positive cure to their economic ills. Global imbalances, U.S., China, and the role of G20 Monetary policies that lead to increased availability of funds and excessive liquidity are necessarily associated with the development of global imbalances (Gang 2009). The latter were the curse and plague of the global economy over the past decade. Today, the largest states are increasingly concerned about the long-term implications of global imbalances for the future of their economic performance. It should be noted, that global imbalances have already become an indispensable element of global economic performance. Simultaneously, a temporary narrowing of the global imbalances turned out to be one of the major side-effects of the global financial crisis (Padoan 2010). The only question is in whether global imbalances have a potential to damage the global economy and what global organizations similar to G20 can do to reduce the current account imbalances in the world’s major economic powers. Before the crisis, global account imbalances were measured as the differences between the world’s account deficits and surpluses (Padoan 2010). In 2008, the differences between account surpluses and deficits gradually rose to reach 5% of the global GDP (Padoan 2010). Given the fragile position of the United States in the global economic system, it comes as no surprise that the U.S. accounted “for the lion’s share of the world’s total account deficits” (Padoan 2010, p.11). Simultaneously, the world’s account surplus was created and sustained by China, Japan, and Germany (Padoan 2010). Following the crisis, the global imbalanced raised almost 50%, as a consequence of the fast slowdown of the economic activity and a decrease in oil prices (Padoan 2010). Apparently, global imbalances are not new to the emerging and developed economies, but sizeable global imbalances and their rapid increase can be potentially damaging to the global economic stability (Padoan 2010). The current state of economy is not simply characterized by the growing gap between countries’ account deficits and surpluses. Further, the mix of the countries responsible for the account surpluses is changing (Padoan 2010). Therefore, it is essential that global economic organizations monitor (a) the state of the global imbalances and (b) the changes in the mix of countries that are responsible for either surplus or deficits in their accounts. Why global imbalances have negative implications for the global economy is not difficult to explain. In normal course of economic development, global imbalances reflect the principles of efficient allocation of resources and savings between the countries with account surplus and those with account deficits (Padoan 2010). Globalization facilitates the inflow of capitals and goods to the countries with the account deficits from the surplus countries. In this way, account deficit countries can readily use additional financial resources to support their economic growth, investment, and capitalization of economy. Simultaneously, surplus countries will have ample opportunities to find better returns for their savings and investments from the deficit countries (Padoan 2010). However, global imbalances may also be the result of the broader, negative economic forces, including the lack of the exchange rate flexibility (Padoan 2010). Today, higher rates of savings in emerging economies present one of the most serious threats to global economic stability. Emerging economies display higher rates of savings compared with their spending, as long as they cannot rely on their healthcare and employment insurance, and their systems of retirement and illness compensation are underdeveloped (Padoan 2010). Nevertheless, these are the global imbalances generated by China and the U.S. that have recently become the issues of the primary economic concern. The current state of global imbalances between the U.S. and China is a result of the complex influences, including the global credit boom and the financial crisis that followed. Excessive savings in emerging economies like China were accompanied by the adjustment and rapid increase in deficits in deficit countries like the U.S. The United States is rightly considered as the leader in excess saving compared with other world countries (Cooper 2005). Excess saving in this county manifests through constant account deficits the lack of investment abroad (Cooper 2005). Excess saving and reluctance to invest abroad by Americans is partially justified by the strength of the American dollar (Chakraborty & Dekle 2009). Another reason why Americans save instead of investing abroad is in that central European countries and other emerging economies make investments equally attractive and insecure (Cooper 2005). Returns on investments to emerging countries are increasingly volatile and subject to the frequent changes in economic, legal, and political strategies (Cooper 2005). Simultaneously, emerging economies like China choose the United States as the principal investment target, due to relatively stability, security, and attractiveness of the American investment climate. “The factors responsible for the current account deficits in the United States include but are not limited to unaccounted value of liquidity services, which the US provides to other countries, as well as the U.S. borrowing from the foreign countries at 5%” (Hausmann & Sturzenegger 2005). Although economic theory predicts that countries facing global imbalances would try to cure their economic ills, the real situation is quite different, and the U.S. does not seem to have made a single step away from its current deficits. The imbalances of saving and investments in the U.S. lead to increased costs of non-investment, reduced productive capacity and lower growth rates (Adams & Park 2009). “The US is not just concerned about the short term risks to growth; it also worries that if Europe pulls the brakes at the same time as the EUR has depreciated sharply, and while China still seems reluctant to allow the RMB to appreciate, global growth could once again become overly dependent on US private consumption” (Annunziata 2010). Actually, China with its account surplus is another issue of the global economic concern. Since 2005, the economic image of China has been constantly associated with the growing account surplus of about 5 percent of its GDP or almost $146 billion (Gang 2009). Despite the fact that China had traditionally maintained its structure of trade balanced, it is due to the growing account deficits in the U.S. that China came to exemplify one of the brightest examples of the large, even excessive account surplus in the global economy. The fact that China invests more than 40 percent of its GDP in investment resources, housing, and industrial development further complicates the situation (Gang 2009). As a result, China contributes to the development of global imbalances and reinforces their negative implications for the future of the global economic stability. The prospects of the global economic recovery are rather gloomy, and G20 was recently considered as the vital element in managing global imbalances between the U.S. and China. On April 13, 2010 the leaders of the Group of 20 met in Brussels to discuss the global implications of account imbalances and the ways of resolving them. Most leaders hold confidence that only China can help to reduce the existing economic imbalances that stem from the country’s growing reserves and excess trade surplus (Reuters 2010). Also, weak yuan increases the problem of global imbalances and calls for faster appreciation of the Chinese currency (Reuters 2010). However, G20 has never succeeded in its financial management endeavors, especially in the context of global imbalances. In November 2010, the G20 again failed to seal an agreement over the currency and trade changes to resolve the existing global imbalances (Verma 2010). Some economic scholars treat global imbalances as an indispensable element of the free flow of goods and capital across countries (Yao 2009). Others suggest that it is a serious mistake to try to eliminate the existing account deficit in the U.S. or at least to reduce it to a lesser sum (Cooper 2005). The problem with G20 is in that mending the global imbalances is not only about the U.S. and China; rather it is about creating a coordinated effort, in which all countries, including the emerging ones, will have to participate. Coordination is possible, if countries have sufficient resources to meet their domestic economic demands (Verma 2010). Emerging markets, too, will have to reconsider the patterns of their domestic consumption (Verma 2010). Therefore, it is essential that all countries engage in the development of a global assessment process, which will lead to the implementation of a common strategy aimed at reducing the existing global imbalances without damaging the domestic economic interests of all parties. References Adams, C & Park, D 2009, ‘Causes and consequences of global imbalances: Perspective from developing Asia’, Asian Development Review, vol.26, no.1, pp.19-47. 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