Quantitative Easing - Exceptional Monetary Tool for Authorities to Revive the Economy - Essay Example

Quantitative Easing Unit Name Lecturer’s Name Date of Submission Introduction Quantitative Easing (QE) is an alternative monetary policy tool applied by the central banks for economic stimulation once the standard monetary policy fails. The ineffectiveness of the monetary policy in the economy compels the central bank to implement QE through buying a fixed amount of financial assets that are long term in nature from commercial banks, as well as other private financial institutions. The overall effect on those financial assets is that their monetary base tends to increase and the yield decreases. This is different from the conventional monetary policy where the government buys or sells its bonds so to maintain interbank lending rates at a particular targeted value. In the event of the economic downturn, the government through the central bank adopts an expansionary monetary policy where the central bank purchases government's short-term bonds so as to lower short-term market interest rates. On the other hand, while the short-term interest rates are close to zero, standard monetary policy may not be effective in lowering the interest rates (John & Akila: p. 699). Therefore, Quantitative Easing may be considered as exceptional monetary tool by monetary authorities to revive the economy. This involves buying assets of longer maturity like the long-term government bonds with newly printed money as compared to short-term financial assets, for instance the short-term government bonds. This method is effective in the long run as it helps in lowering the long-term interest rates. Conversely, the prices of the financial assets tend to augment thus lowering their yield. Hence, QE can be used as an option to maintain inflation at the required level and ensure that it does not fall beneath the targeted level. However, QE may be more effective than anticipated in the long run leading to higher inflationary rates due to rise in money supply in the economy. Similarly, the policy may be ineffective when the bank fails to lend out extra reserves (William & Michael: p. 298). Quantitative Easing Versus Monetary Policy QE is distinct from the conventional monetary tools applied by the central bank. In most cases, the monetary policies concentrate on the interest rates charged by the banks while lending out the money. When the interest rates are almost zero as a result of exceedingly reduced money demand or deflation, when a large amount of defaulted loans hinder further lending, and when the entire economy is at depression since the banks are incapable of further lending, then there is a need for the central bank to come up with a solution. This calls for quantitative easing as a remedy. Therefore, the central bank may propose for QE through buying a specified long-term government bonds without relying on the rates of interest. The main objective of this monetary tool is boosting the money supply, as opposed to decreasing the interest rates, which becomes practically impossible to be reduced further. However, this is generally considered a last option to revive the economy (Michael & Frank; p. 18). History Quantitative easing in Japan can be traced back to March 2001, after a zero interest rate policy period. The Bank of Japan used to buy Japanese government Bonds as a way of accomplishing their main goal of current account balances, which was held as bank reserves. The Bank of Japan (BOJ) abandoned quantitative easing in 2006 due to scary evidence that the economy was growing out of deflation. After experiencing worldwide financial sabotage, the Bank of Japan escalated the purchasing rate of Japanese Government Bonds and subsequently adopted several exceptional measures that fostered financial stability. In 2010, the Bank of Japan implemented another policy that was known as Comprehensive Monetary Easing to curb the appearance of yet another deflation and a lagging recovery. One of exceptional measures was the introduction of asset purchase plan involving government securities with private assets inclusive (Ugo, Qing & IMF: pp. 5-10). Study on the effectiveness of quantitative easing has produced different results; more so on identifying the inadequate effects on economic goings-on. Other studies have shown that quantitative easing has assisted in reduction of inflation, its effect on the economy and its yields was found to be minimal. There was a number of reasons mentioned that included a deteriorating banking sector with malfunctioned credit panels, and frail demand for loans during times when corporate were deleveraging. This situation has gained a lot of improvement alongside strengthening of bank’s balance sheets and reforming corporate after the crisis of the banking sector in 1990s (William & Michael: p. 300) . There is an underlying question of effectiveness of quantitative easing measures in Japan given that the banking and corporate sectors are improved. After Lehman collapse, there is a continual assessment of quantitative easing impacts on economic activity and inflation in duration of analysis to 2010. There is some fact that monetary easing has propped economic activity and lightly to inflation. Japan has witnessed the real experience with quantitative easing and saw that BOJ’s monetary policy undertakings have assisted in decline of yields. Within 2001-2006 era of QE, Current Account Balances augmented slowly from around 5 trillion Japanese yen to 36 trillion Japanese yen in 2004 before decreasing at the end of 2006. To achieve Current Account Balances targets, the BOJ mainly bought long term Japanese Government Bonds. The earlier researchers narrowed mainly on chosen transmission platforms that comprised keeping anticipated interest rates low for a prolonged period of time; and signalling effects resulting from extension of the balance sheet and portfolio re-harmonizing and inclined rate of purchases of JGBs. The strongest of the effects was found to be a commitment. The signalling effects and portfolio balancing was much portrayed mixed with positive evidence of lowering yields when CABs higher and JGB in the long term (Ugo, Qing & IMF: pp. 5-10). However, it was noted that impact on economic activity was limited. Some studies demonstrated that quantitative easing assisted to create a more accommodative state for corporate funding and improved the lending nature of financial institutions, reduced inflation and the impact on economic activity. The reason was the sabotage of credit platforms because of a feeble banking system after aforementioned crisis of 1990 and corporate deleveraging. There is a suggestion about developed countries that have experiences on quantitative easing that the central bank purchases has been most effective means of improving economic activity and shunning deflation. Following Fed’s asset purchase program, it was found that FRB/US model of securities from 2008 was found to lower the unemployment rate by 1.5% points. Furthermore, it was later found that asset purchases averted deflation to a certain extent. Richard (2012: p.177) provided the change-point VAR model and approximated that the asset purchase program of Fed’s decreased 1o-year interval by a mean of 90 points over and during the crisis period. The unemployment velocity was approximated to be 0.7 percent higher and inflation mean of one percent lower in 2010, without the idea of a proxy for asset purchase program. Due to worldwide financial recession and unrelenting deflation, the BOJ extended its policy toolkit to comprise absolute purchases of commercial papers and corporate bonds, extension of absolute purchases of JGBs, fixed rate finance providing operations, and supporting growth. These measures helped curb financial recession and the recovery began to crawl, making the BOJ resume on a good time on its new Comprehensive Monetary Easing policy. The Comprehensive Monetary Easing policy had three elements: zero interest rate policy, an effort to keep zero interests rate constant up to the time when BOJ addresses the issue of long-term understanding of price stability, and an original asset purchase program on government bonds and other securities. Because of earthquake phenomenon, the BOJ multiplied the size of the asset purchase program in twofold to ten trillion Japanese Yens. Consequently, the large BOJ balance sheet was approximately twenty percent GDP and later expanded to thirty percent (Vladimir, Phil, Krishna & IMF: p.9). After studying the BOJ’s policy actions, there is a trend of statistical impact on asset prices. A study by William (2002: p.10) shows the analysis of the impact of the formulated monetary policy activities and identified the cumulative effects of BOJ’s portfolio of easing on various markets; independence yields decreased and so is the corporate yield. With similar effects, the stock market improved with four out of five easing events and an aggregate of percent 5-7% increase. Another study done by Ilian (2013: p.64) suggested that some of measures that were used by BOJ created the anticipated impacts on the asset with exchange rate exclusive. Since the beginning of the 2007-2008 financial crisis, the United States of America, the European Union and the United Kingdom have used similar policies. The reason as to why these countries used these policies were because of their risk-free short-term interest rates that were either at zero or were too close to zero. In the US, the federal fund rate forms the interest rate while in the interest rate in the UK is basically the official bank rate. At the period of the 2008 financial crisis, the Federal Reserve of the United States stretched its balance sheet significantly by incorporating new assets, as well as new liabilities without covering for these equivalent subtractions in their expansion. Similarly, during the same period, quantitative easing was used by the United Kingdom to curb its financial crisis as a supplementary monetary tool. Prior to the recession, the Federal Reserve of the US held the Treasury notes to a tune of $700billion and $800 billion on its balance sheet. However, in November 2008, it commenced purchasing $600 billion in financial securities that were usually in the form of mortgages (Vladimir, Phil, Krishna & IMF: p.9). In its adoption of the QE policy, the Bank of England purchased gilts mainly from financial institutions coupled with lesser amounts of moderately high-quality debt provided by the private companies. The insurance firms together with private banks would spend the money received for lending and purchasing extra bonds from the commercial banks. The central bank was able to lend the newly printed notes to buy bonds from banks where the banks would receive the currency instead. The overall effects of the quantitative easing were to depress the interest yields on the government bonds together with related investments so as to make it easy for firms to raise capital. Another, shortcoming of the QE is that investors may tend to look for alternative investments, like the shares, thereby raising the price and hence encouraging consumption. Quantitative easing has the tendency or decreasing interbank overnight interest rates, hence, compelling the banks to lend money to borrower at relatively higher interest rates (William: p.10). In most developed countries (e.g. Japan, the European Union, UK and the US), the central banks are restricted from directly purchasing government bonds and instead they purchase from secondary markets. This process under which the government sells the bonds to businesses and households and later the central bank purchases them has been widely referred to as ‘monetizing the debt’ by several economic analysts. The difference between the QE and debt monetization is that, through the QE, the central bank prints out money for economic stimulation, as opposed to financing government expenditure. Similarly, the central bank expects to reverse the QE upon stabilization of the economy. This would be facilitated through the resale of government bonds together with other financial assets in the market. However, the most effective mechanism to establish monetization of debt by the central bank is to ascertain whether its performance aligns with their laid out objectives. Nonetheless, most central banks have implemented inflation target. Remarkably, since 2002 the government of the United States has had a technology referred to as the printing press. If the interest rates approaches zero, the government would respond accordingly to prevent deflation (Richard: p.175) . Economic impact Quantitative easing my augment the inflation rates than anticipated if the necessary amount of easing is overestimated and the amount of money circulating in the economy is too much, originating from purchase of liquid assets. Similarly, the EQ may be ineffective should the bank fail to lend extra money to households together with the business for investing thereby lowering the demand. However, QE has the capacity of easing the deleveraging process as it has the tendency of lowering the yields. Similarly, there is a time lag between inflation and the growth of the money, inflationary pressures linked with the growth of money from the QE could result before an action is taken by the central bank to offset it. Risks from inflationary pressures could only be minimized if the economy responds positively to the increase in the money supply resulting from newly printed notes (William: p.10). On the other hand, the unit worth of the currency may also tend to increase regardless of more money in circulation. For instance, if the nation would strive to increase the output in the economy with a relatively higher rate than the debt monetized, then there would be stability in the inflationary pressures. This would only have a positive impact if the commercial banks would agree to loan the excess money to businesses and households instead of hoarding it. Throughout the period of high economic output, there is a need for the central bank to maintain reserves at a relatively higher level by means of raising interest rates. Consequently, this would help in reverse the negative implications QE could have on the economy (Richard: p.175). Conclusion Quantitative easing as an alternative monetary policy tool may have the susceptibility of depreciating the exchange rates of individual nation’s currency against the currency of other countries. This is usually accelerated through the means of interest rates as a means of stabilizing the economy. The overall effect of lower interest rates would be capital outflow from a nation implicating negatively the demand for the nation’s currency, hence weakening it. However, QE tends to benefit exporters and debtors due to the fall of interest rates, implying that the debtors will take advantage of lower interest rates to repay less money than they had actually borrowed. Similarly, creditors are worse off as they as they receive less money from debtors than they had actually lent out as a result of lower interest rates. Similarly, depreciation of the currency would have a negative implication on the importers as the value of imported goods is inflated due to devaluation of the currency. Works Cited Ilian Yotov. The quarters theory : the revolutionary new foreign currencies trading method. Hoboken, N.J. : Wiley, 2013. Print. John B Taylor & Akila Weerapana. Principles of Economics. Mason, OH: South-Western Cengage Learning, 2012. Print. Michael M Hutchison & Frank Westermann. Japan's great stagnation : financial and monetary policy lessons for advanced economies. Cambridge, Mass.: MIT Press, 2006. Print Richard Duncan. The new depression : the breakdown of the paper money economy. Singapore ; Hoboken, NJ : John Wiley & Sons Singapore Pte. Ltd., 2012. Ugo Fasano-Filho, Qing Wang & IMF. Bank of Japan's Quantitative and Credit Easing: Are They Now More Effective. Washington, D.C.: International Monetary Fund, 2002. Print Vladimir Klyuev, Phil De Imus, Krishna Srinivasan & International Monetary Fund. Unconventional choices for unconventional times : credit and quantitative easing in advanced economies. Washington, D.C. : International Monetary Fund, 2009. Print. William J Boyes & Michael Melvin. Economics. Australia ; Mason, OH : Cengage Learning South-Western, 2013. Print. William W Grimes. Unmaking the Japanese miracle : macroeconomic politics. Ithaca, NY [u.a.] Cornell Univ. Press, 2002. Read More