Influence of Quantitative Easing Monetary Policy on Japan and the US - Research Paper Example

Lecturer: Influence of quantitative easing monetary policy on Japan and the United s Introduction Quantitative easing is a form of monetary policy utilized by central banks in order to stimulate the economy in the event that standard monetary policies do not function in the manner they should (Ford 160). Central banks implement quantitative easing through purchase of specific financial assets from commercial banks and other private institutions therefore increasing the prices of the same financial assets while decreasing their yield and increasing the monetary base at the same time. This is different from the typical policies of buying or selling government bonds so that interbank rates can be maintained at a specific target value. Expansionary monetary policies aimed at stimulating the economy usually involve central banks buying short-term government bonds so that the market interest rates can be lowered. Nonetheless, when short-term interest rates go towards zero, this approach may no longer be effective. In this kind of situation, the monetary authorities may employ the use of quantitative easing to stimulate the economy through purchase of assets that mature in the long-term rather than short-term government bonds, therefore decreasing the interest rates away from the yield curve. Quantitative easing may be important in assisting to make sure that inflation does not go below the target, but it has risks including over-efficacy than originally intended against deflation, thereby resulting in higher inflation in the longer term from increased supply or sufficiently effective in the event that additional reserves are not lent out by banks. Based on the opinion of various economists as well as the IMF, quantitative easing used since the beginning of the financial crisis that was experienced between 2007 and 2008, has been critical in mitigating various adverse impacts of the crisis (Gindin and Panitch 326). Practices of quantitative easing Various economists and analysts argue that the US Federal Reserve employed some type of quantitative easing from 1930 all the way to 1940s in the fight against the Great Depression. Nevertheless, as the Federal Reserve employed quantitative easing initiatives to address the effects of 2007-08 financial crisis, various critics have considered its actions extraordinary. Further, charts have been created to point out that, as a fraction of GDP, the balance sheet after the financial crisis had not gone past the percentages that were attained between 1939 and 48 as of May 2013. Before the 2007-08 financial crisis The phrase “quantitative easing” was for the first time employed by the Bank of Japan when it was dealing with domestic deflation at the turn of the millennium. The Bank of Japan embraced the approach in March 2001 regardless of the fact that it had stated for a long time that qualitative easing was not effective while rejecting its use as a monetary policy (Kates 145). Japan’s central bank had managed to maintain short-term interest rates at almost zero from 1999 but while using quantitative easing, it swamped the commercial banks with surplus liquidity with the aim of promoting private lending and this left them with large stocks of surplus reserves and decreased risk of shortages in liquidity. Bank of Japan achieved this through purchase of more government bonds that those needed to bring the interest rates to zero, as well as buying securities that were asset-backed and equities while extending the terms of its operations for commercial paper purchasing. Through this endeavors, Bank of Japan was able to increase current account balance of the commercial bank from five trillion Yen to thirty-five trillion Yen through a period of four years beginning from March 2001. It was also able to triple the amount of long-term governmental bonds that it was able to buy every month. US after the 2007-08 financial crisis From the beginning of the global financial crisis that occurred between 2007 and 2008, polices such as quantitative easing have been employed by the US, the UK as well as the rest of the Eurozone. Quantitative easing was adopted by these three nations as a result of their short-term minimal interest rates that were risk free at zero or near zero. In 2008 at the height of the financial crisis, the federal reserve of the US intensely expanded its balance sheet through adding new assets along with new liabilities without sterilizing them using equivalent deductions (Kolb 486). At the same time, the UK also employed quantitative easing as an additional approach to the monetary policy it had utilized so that it could deal with the financial crisis. The Federal Reserve had an estimated seven hundred to eight hundred billion dollars of Treasury notes in its balance sheet prior to the recession. The Federal Reserve began purchasing six hundred billion dollars in mortgage-backed securities in late November 2008 and by March the following year; it was holding 1.75 trillion in bank debt, treasury notes and mortgage-backed securities. More buying was stopped since the economy had started improving but it continued in mid-2010 when the Federal Reserve realized economic growth was stagnating. Subsequent to the halt, holdings began decreasing unsurprisingly since debt reached maturity and was forecasted not to reach the 1.7 trillion mark by 2012. The revised goals of the Federal Reserve switched to maintaining holdings at 2.054 trillion, and to sustain this level, it purchased thirty million in two-to-ten year treasury notes on a monthly basis. The Federal Reserve made the announcement of a second round of quantitative easing in November 2010 and bought six hundred billion in Treasury Securities as of the second quarter of 2011. Consequently, QE2 developed into a universal diminutive in 2010, used while referring to the second round of quantitative easing instigated by the central banks of the US. In retrospect, the initial round of quantitative easing that had preceded QE2 started being referred to as QE1. QE3, which was the third round of quantitative easing, began in September 2012 where the Federal Reserve made the decision to instigate a forty billion open-ended monthly purchase initiative of mortgage-backed securities for the agency (OConnor 208). Furthermore, the Federal Open Market Committee declared it would most probably keep federal funds rates at near zero all through to 2015. This could be considered a stimulus program the enabled the Federal Reserve to release forty billion dollar each month of the debt risk in the commercial housing market. As a consequence of its open-ended characteristic, QE3 was given the widely held nickname of QE-Infinity. In December 2012, FOMC declared increased in the quantity of open-ended buys, which grew from forty billion dollars up to eighty-five billion dollars each month. In mid-2013, the Federal Reserve announced the tampering of a number of the Federal Reserve’s QE policies based on the positive economic data that had been recorded. Particularly, Federal Reserve had the ability to cut down on the purchase of bonds from eighty five billion dollars to sixty five billion dollars every month prior to the policy meeting that was to be held in September 2013. It was also likely that the bond-purchase program could end in mid-2014 and even though the increase in interest rates was not announced, there were suggestions that if inflation went towards the two percent target rate and the rate of unemployment fell to 6.5 percent, the Federal Reserve would probably begin increasing the rates. Japan after the 2007-08 financial crisis Bank of Japan announced in October 2010 that it would evaluate purchase of five trillion Yen in assets in an effort to lower the value of the Yen against the dollar so that the domestic economy can be stimulated through making Japanese exports cheaper but this was not successful. In August 2011, Bank of Japan publicized an independent move towards increasing the current account balance of the commercial bank from forty trillion Yen to fifty trillion Yen and in October, it increased the asset buying initiative by five trillion yen to reach fifty five million Yen. In April 2013, the Bank publicized its intention to increase its asset-purchasing program by sixty to seventy trillion Yen every year. The Bank was hoping to transform Japan from deflation to inflation with its goal being two percent inflation. The level of purchases was so high to the point that it was projected to double the money supplied with this policy being called Abenomics, named after Japan’s Prime Minister (Morgan 86). Towards the end of 2014, Bank of Japan publicized the expansion of its bond purchasing initiative to start purchasing eighty million Yen of bonds yearly. Central bank assets of various central banks between 2007 and 2015 Effects of quantitative easing As per the IMF, quantitative easing that was instigated by central banks of the US and Japan from the beginning of the financial crisis have greatly contributed to the decrease of general risks especially after the Lehman Brothers became bankrupt. The IMF has stated that these policies led to the improvements seen in market confidence as well as bottoming-out of the recession in the economies of G7 nations later in 2009. There are arguments that QE2 resulted in an increase in the stock market later in 2010 and this led to increased intake and a resilient performing US economy. By mid-2012, there were still limited effects on the economy and the measures of quantitative easing like asset purchases in large scale have had a considerable part in the support of economic activities. Quantitative easing may result in higher inflation rates than the ones that are desired if the degree of easing needed is over-estimated leading to the creation of excess money through buying liquid assets (Katz 129). Conversely, qualitative easing may fail to inspire any demand in the event that banks continue to be reluctant to lend money to various entities including households and businesses. Even so, qualitative easing still has the capacity to make the process of deleveraging simpler since it results in lower yields. Nonetheless, there is exists a time lag between monetary growth and inflation with the pressure from inflation linked to increase in money from quantitative easing being able to grow before the central bank can instigate acts that address them. Risks of inflation can be mitigated if the economy of the system grows too big for the rates of increase of the supply of money from the easing. In the event that an economy’s production increased as a result of increase in the supply of money, a currency’s value is also likely to increase regardless of the fact that there is increased currency available. For instance, if the economy of a country was to demonstrate a considerable increase in its output at a rate that is equal to the amount of monetized debt, pressure from inflation can be equalized. This may only occur if banks that are members lend the surplus money rather than hoarding it and in the periods of high economic output, the central bank has the discretion of restoring reserves to increased levels by increasing the rate of interest to reverse the measures taken in an effective manner. An increase in the supply of money typically depreciates the rate of exchange of a nation in comparison to other exchanges by interest rate mechanisms. Low rates of interest lead to the outflow of capital from a nation and thus a decreased foreign demand for a nation’s currency and consequently weakening the currency (Grauwe 319). This aspect of quantitative easing provides direct benefits for exporters and debtors in nations that employ the approach as it decreases interest rates, implying that less money needs to be repaid. Nonetheless, it is directly harmful to creditors since they get less money from the low interest rates while the devaluation of a currency is harmful to importers since the cost of inflated commodities increases because of the devaluation of the currency. In the US, quantitative easing initiatives instigated by the Federal Reserve had the likelihood of contributing to decreased rates of interest for corporate bonds as well as mortgage rates that will assist in supporting the price of houses. They also had the capacity to contribute to higher valuation of the stock market, higher rates of inflation and expectation for future inflation for investors, increased job creation as well as an increased rate of GDP growth. Risks associated with quantitative easing Critics have argued quantitative easing leads to capriciousness and since an increase in the bank reserves may not have an immediate increasing effect on the supply of money when held as surplus reserves; the escalated reserves develop a risk of inflation that may be created when reserves are lent out (Kates 34). Other critics are also of the opinion government bond interest rates that have been decreased artificially through quantitative easing may have severe effects in underfunding status of pension funds. This is because returns that are more than inflation result in investors facing the actual values of decreasing savings instead of increasing in a number of years. New money created through quantitative easing may be used for investments in emerging markets; economies based commodities as well as commodities themselves instead of lending to the local businesses that have trouble in their attempts to secure loans. Main regressions A six variable Value at Risk was run using growth and key inflation without including fresh food all rates, minimal effective exchange rates, five year spreads as well as prevailing account balances of the Bank of Japan as part of the GDP. Increases in the prevailing account balances at the Bank of Japan seem to be increasing growth and core inflation, however, the statistical implication is weak with the peak impact appearing at about three-quarters. Accumulated impulse responses demonstrate that an unexpected increase in the prevailing account balances by around two percent of the GDP may drive up growth by 1.8 percent in two years as well as core inflation by approximately 0.6 percent. Focusing on the tools that increase the prevailing account balances; it can be seen that the purchase of Japanese Government Bonds instead of short-term T-bills seems to be more effective in encouraging activity. Nonetheless, when considering a sample size of 2001 to 2010 in regards to Bank of Japan’s assets, it is impossible to consider the same period with earlier regression. A Value at Risk can be run using the government bonds held by Bank of Japan as a share of the outstanding Japanese Government Bonds. Founded on accumulated impulse responses, an expected increase of five percent in Japanese Government Bonds held by the Bank of Japan may increase the rate of growth by approximately one percent in a year but this has been identified to have minimal effects on inflation. The effect of actions associated with the Bank of Japan’s monetary policy can also be evaluated in relation to unemployment. If regression is rerun using unemployment as the indicator of economic activities, the same results may be realized. Accumulated responses to impulse demonstrate that unemployment decreases by almost 0.4 percent in two years in reaction to an un-forecasted increase in the prevailing account balances of almost two percent of the GDP. Conclusion From the beginning of the financial crisis of 2008, a number of the biggest central banks in the globe including US Federal Reserve and Bank of Japan embarked on quantitative easing. This was an unconventional manner of pumping money back into the economy and seeking to decrease interest rates in the longer term so that recession could be addressed. As rates of interest in industrial nations had declined to almost zero subsequent to the global crisis, the magnitude for additional monetary easing by using lower policy rates was restricted. Various asset purchase programs as well as quantitative easing were adopted under extraordinary situations with Japan being considered as the first nation to implement quantitative easing as early as 2001. However, it was not until the financial of 2008n that most central banks, particularly in the developed nations, began employing qualitative easing in order to stimulate their respective economies, increase lending by banks and inspires more spending. The bubble in the real estate sector of the US that burst in 2007 was the main cause of the financial crisis and the recent debt crisis in Eurozone have forced various central banks to seek aggressive monetary measures like qualitative easing so that they may prevent financial instability. US’ Federal Reserve instigated QE1 in 2008, followed by QE2 in 2010 and Operation Twist in 2011 before introducing QE3 in 2012. QE3 involved an injection of eighty five billion dollars every month through purchasing mortgage backed securities as well as treasury securities over a long-term. The Federal Reserve purchases bonds from the government or other bonds and makes the money available for lending to banks consequently increasing the amount of money that circulates in the economy. This initiatives and actions of quantitative easing subsequently decrease the long-term interests. Works Cited Ford, Wayne N. Constitution, Government, Politics And The Economy. [S.l.]: Friesenspress, 2013. Print. Gindin, Sam, and Leo Panitch. The Making Of Global Capitalism. London: Verso, 2012. Print. Grauwe, Paul de. Exchange Rate Economics. Cambridge, Mass.: MIT Press, 2005. Print. Kates, Steven. Macroeconomic Theory And Its Failings. Cheltenham, UK: Edward Elgar, 2010. Print. Kates, Steven. The Global Financial Crisis. Cheltenham: Edward Elgar Pub., 2011. Print. Katz, Richard. Japanese Phoenix. Armonk, N.Y.: M.E. Sharpe, 2003. Print. Kolb, Robert W. Lessons From The Financial Crisis. Hoboken, N.J.: Wiley, 2010. Print. Morgan, Tim. Life After Growth. Petersfield, Hampshire, Great Britain: Harriman House, 2013. Print. OConnor, David. Deciphering Economics. Santa Barbara: ABC-CLIO, 2014. Print. Appendix Regression analysis data The data utilized for correlations and regression analysis in the evaluation of the impact of quantitative easing from 2001 to 2010 was converted to replicate its value in US dollars as follows: Japanese annual bond purchase Year BOJ bond purchase in Yen In USD 2010 27,000,000,000,000 307,587,149,692 2009 26,200,000,000,000 279,974,353,494 2008 18,200,000,000,000 175,981,434,926 2007 16,800,000,000,000 142,650,929,778 2006 16,800,000,000,000 144,466,420,157 2005 18,000,000,000,000 169,502,588,791 2004 19,200,000,000,000 177,564,043,281 2003 19,200,000,000,000 165,631,469,979 2002 16,200,000,000,000 129,413,644,352 2001 7,200,000,000,000 59,269,015,476 Historical FX Rates Year USD/JPY JPY/USD 2010 87.78 0.0114 2009 93.58 0.0107 2008 103.43 0.0097 2007 117.77 0.0085 2006 116.29 0.0086 2005 110.09 0.0091 2004 108.13 0.0093 2003 115.92 0.0086 2002 125.18 0.008 2001 121.48 0.0082 Japanese goods exported to the US Year $ Exports in USD 2010 120,552,145,178 2009 95,803,683,368 2008 139,262,197,032 2007 145,463,342,556 2006 148,180,775,579 2005 138,003,696,155 2004 129,805,198,658 2003 118,036,645,528 2002 121,428,705,198 2001 126,473,307,145 Read More