Influence of Quantitative Easing Monetary Policy on Japan and the United States - Case Study Example

Lecturer: Influence of Quantitative Easing Monetary Policy on Japan and the United s 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 the purchase of specific financial assets from commercial banks and other private institutions. Therefore, the price of the same financial assets increases while decreasing their yield and increasing the monetary base at the same time. The principal aim of the study was to evaluate quantitatively the quantitative easing monetary policy influence on Japan and the United States. This evaluation is based on the fact that the IMF stated that these policies led to the improvements were seen in market confidence as well as bottoming-out of the recession in the economies of G7 nations later in 2009. Introduction The motivation to conduct a study on QE was the IMF instigating measures to US and Japan. The Methodology used was the collection of data and interviewing the relevant authorities in Japan and US. As per the IMF, quantitative easing was instigated by central banks of the US and Japan from the beginning of the financial crisis have significantly contributed to the decrease of general risks especially after the Lehman Brothers became bankrupt. In the study, there are variables that were selected from the given dataset and they include certificates of deposits, return on assets, and total asset of banks, TED spread, Amihud index and stock returns in the year 2009. Japan however never used QE. Amihud index represented the market liquidity risk while certificates of deposits represented the funding liquidity risk. The selected variables were used to evaluate the quantitative easing. The first section of this paper is based on theory analysis where, different data are discussed in order to describe how the changing of policies affected the United Stated and Japan. Supportive data is available from research institutes. The second section entailed showing how quantitative easing monetary policy has an influence on Japan and the United States using the dataset provided. Quantitative Easing is different from the typical policies of buying or selling government bonds so that interbank rates can be maintained at a particular 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 practical. 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. Care is necessary to prevent any future economic crisis. 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 used quantitative easing initiatives to address the effects of the 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 during that period. 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. The comparison is important in helping us understand the background of Japan and US (Kates 145). Japans 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 excess 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, Japan was able to increase the current account balance of the commercial bank from five trillion Yen to thirty-five trillion Yen through a period of four years beginning on March 2001. It was also able to triple the amount of long-term governmental bonds that it was able to buy every month. From the beginning of the global financial crisis that occurred between 2007 and 2008, policies such as quantitative easing have been employed by the US, the UK as well as the rest of the Eurozone. Japan and US adopted Quantitative Easing 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 by 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 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 Reserves 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 The 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 would be stimulated by making Japanese exports cheaper but this was not successful. In August 2011, The 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. In October, it raised 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 increase. 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 Japans 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. Theoretical Analysis. Effects of Quantitative Easing As per the IMF, the quantitative easing that was instigated by central banks of the US and Japan from the beginning of the financial crisis has significantly 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 were 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 than 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. In regards to the variables in the dataset provided, the quantitative effect could be represented as: Y1 = + 1 X1 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, quantitative easing still has the capacity to make the process of deleveraging simpler since it results in lower yields. Nonetheless, there exists a time lag between monetary growth and inflation with the pressure from the inflation linked to increasing 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 becomes too big for the rates of an increase in the supply of money from the easing. In the event that an economys production increased as a result of the increase in the amount of money, a currencys 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 efficient 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 country and thus a decreased foreign demand for a nations currency and consequently weakening the currency (Grauwe 319). This aspect of quantitative easing provides direct benefits for exporters and debtors in countries 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 dangerous to importers since the cost of inflated commodities increases because of the depreciation of the currency. In the US, the 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 the 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. By definition, the TED spread is the difference between the interest rates where, the government of USA borrows Treasury bill for a period of three months. The TED spread shows the credit risk between interbank lending as well as banking system health. It as well acts as an indicator that is considered to boost the confidence of the investor on the federal government and financial system. Basing on the below figure, it is observed that the mean of all TED spread of the key nations is relatively high at 161.94, and this implies that the banks default rate is high. Basically, it is required for TED spread to within 10-50 bps but is observed to be relatively high. A high TED spread indicates a downturn in USA stock market, and this implies that there is reservation of liquidity. The TED spread is as well seen to be high at around 2008 where, there was a financial crisis . For the above figure, it is observed that the monthly stock return percentage is highly fluctuating, and it is minimal at -0.6 percent in 2008 maximum at 0.8 percent in 2009.This signifies a global financial crisis that was triggered by liquidity. The economic model used here is regression analysis and simulation models. The analysis is that the relationship between the two variables must be ascertained to help analyse the economic crisis of QE in Japan and US Risks Associated With Quantitative Easing Critics have argued quantitative easing leads to capriciousness in the overall economic status 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 on the 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. The new money created through quantitative easing may be used for investments in emerging markets; economies based commodities as well as products themselves instead of lending to the local businesses that have trouble in their attempts to secure loans. The QE faces potential risk as shown by the simulation model. Japan for instance has shown a high risk of suffering from the QE as shown by the simulation model above. Data Section USA and Japan were considered in the study since they had the variables of interest as well as they were seen to follow the targeted inflation during the period of 2000-2008.They were considered to have a high level of capital mobility and independent central bank. The analysis covered the period between 1999 and 2014. Basing on the theory above, it can be noted that quantitative easing has an effect on certificates of deposits (funding liquidity risk), return on assets, total asset of banks, TED spread, Armihud index(market liquidity risk) and stock returns. This dataset is for the fiscal years from 1999 to 2014.The first step was to run a correlation analysis between Amihud index (market liquidity risk) and CDS) that represented the funding liquidity risk. The regression analysis was as well undertaken between the variables in the dataset to understand how quantitative easing influenced Japan and USA. Correlation Analysis After undertaking the correlation analysis between funding liquidity risk and market liquidity risk (Appendix 1), I was able to note that there is a positive relationship between these two variables during the period provided. It is also observed that the correlation between these two variables is significant. According to the literature, it is indicated that there is a strong relationship between funding liquidity risk and market liquidity risk (Brunnemeier and Petersen 23).When there is an indication by the banks that there is a funding constraint in the market, the price of assets being traded will decline, and this will lead to a big risk associated with funding liquidity. In this case, the asset prices that are falling will lead to increased margin calls from the traders, and this will indicate an increased risk related to funding liquidity. The banking institutions will attempt to sell more assets to maintain their positions, and this will result in the asset prices declining as well as there will be a higher margin calls in the markets. The interaction that exists between the market liquidity risk and funding liquidity risk is considered to play a critical role in stimulating a financial crisis situation on a wide canvas (Brunnemeier and Petersen 15). Moreover, this relationship is critical in ensuring that funding liquidity matches the market price of assets. In order to keep an eye on the potential harm of economic crisis, this simulation was critical for the two variables collected. Additionally, this correlation analysis is done to identify the deviation of the economic models from the data presented by QE for Japan and US. Regression Analysis The regression analysis was undertaken to generate model 1(Appendix 2) where, the market liquidity risk was taken as the dependent variable and funding liquidity risk as the independent variable. According to the results, it is observed that there is an interrelation between these variables through regression analysis. The model 2(Appendix 1) is seen not to show satisfactory results due to the small R-squared, which signifies variation in the data. On the other hand, a regression analysis between certificates of deposits and return on assets, total asset of banks, TED spread, Amihud index and stock returns was as well undertaken. It is as well observed that the model is not satisfactory since the R-squared value (1.4%) is too small to explain the variations in the data. The coefficient values represent the type of relationship that exists between the dependent variable and independent variables. Between the year of 1999 and 2014, it is observed that the return on assets; total asset of banks; TED spread; Armihud index and stock returns all influenced the funding liquidity risk negatively. The relationship between these variables is seen to be significant. In relation to this, the 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 dangerous to importers since the cost of inflated commodities increases because of the depreciation of the currency. The motivation from the data findings is to create a coherent relationship of the QE as it is applied in US and Japan to get the relevant data for analysing the Economic crisis mathematically. Conclusion From the beginning of the financial crisis of 2008, a number of the biggest central banks in the world including the US Federal Reserve and the 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 the 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 crisis of 2008 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 primary 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. Brunnermeier, M., & Pedersen, H. L. (2007). Market Liquidity and Funding Liquidity. The Review of Financial Studies. Appendix 1:Correlation analysis Table 1. Correlations Amihud_index cds Amihud_index Pearson Correlation 1 .081** Sig. (2-tailed) .000 N 2013 2013 cds Pearson Correlation .081** 1 Sig. (2-tailed) .000 N 2013 2013 **. Correlation is significant at the 0.01 level (2-tailed). Appendix 2. Regression analysis Model 1 Variables Entered/Removeda Model Variables Entered Variables Removed Method 1 cdsb . Enter a. Dependent Variable: Amihud_index b. All requested variables entered. Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1 .081a .007 .006 .0032988 a. Predictors: (Constant), cds ANOVAa Model Sum of Squares df Mean Square F Sig. 1 Regression .000 1 .000 13.207 .000b Residual .022 2011 .000 Total .022 2012 a. Dependent Variable: Amihud_index b. Predictors: (Constant), cds Coefficientsa Model Unstandardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) .001 .000 16.962 .000 cds 6.523E-007 .000 .081 3.634 .000 a. Dependent Variable: Amihud_index Model 2 Variables Entered/Removeda Model Variables Entered Variables Removed Method 1 totalasset, Stock_return_monthly, roa, tedspread, roeb . Enter a. Dependent Variable: cds b. All requested variables entered. Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1 .385a .148 .146 382.2193657 a. Predictors: (Constant), totalasset, Stock_return_monthly, roa, tedspread, roe ANOVAa Model Sum of Squares df Mean Square F Sig. 1 Regression 49942227.202 5 9988445.440 68.371 .000b Residual 287362262.798 1967 146091.644 Total 337304490.001 1972 a. Dependent Variable: cds b. Predictors: (Constant), totalasset, Stock_return_monthly, roa, tedspread, roe Coefficientsa Model Unstandardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) 307.234 16.173 18.997 .000 Stock_return_monthly -92.491 15.633 -.128 -5.916 .000 tedspread -.375 .065 -.125 -5.787 .000 roe -2.403 .222 -.246 -10.848 .000 roa -27.332 3.997 -.156 -6.838 .000 totalasset -6.268E-008 .000 -.076 -3.614 .000 a. Dependent Variable: cds Appendix 3.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