The Ever Decreasing Effects of Monetary Stimul - Research Paper Example

Many Austrian economists predicted massive inflation after the Federal Reserve announced QE1 & QE2, why haven’t we seen that? of the Name of the university: Introduction The macro and micro economic systems of the globe are significant aspects that have to be adequately monitored, controlled and evaluated in order to understand the feasibility, growth and sustainability of the economic systems of different countries across the world. The monetary and fiscal policies employed in different economies play a crucial role in determining the global economic landscape. Of these, the role of the United States of America is highly profound and influential in shaping the global economy because of the powerful and influential nature of the nation. As such, the Quantitative Easing techniques used by the Federal Reserve of the United States as a key monetary policy is a highly debatable and a commonly analyzed topic with respect to the macro economic studies. This report is aimed at conducting a research work with the objective of understanding why the Austrian economists had predicted massive inflations related to the Quantitative Easing announcements made by the United States Federal Reserve while the rest of the economists across the world have shown a distinct foresightedness regarding these kinds of consequences of the announcement of the Quantitative Easing 1 and Quantitative Easing 2 in the years, 2009 and 2010, respectively. Research objectives Both primary and secondary research objectives are formulated for the study. The primary research objective for the study is to analyses how the Austrian economists have been able to predict the massive inflation experienced in the global economic construct after the implementation of the Quantitative Easing 1 and Quantitative Easing 2 by the United States Federal Reserve in the years 2009 and 2010, respectively. For this purpose, some secondary research objectives are also formulated that would help to support the arguments and findings presented in the process of attaining the primary research objectives. The secondary research objectives for the study are the identification and analysis of the relation between Quantitative Easing and inflation, the study of the history and impacts of Quantitative Easing 1 and Quantitative Easing 2 on the economy of the United States and the other countries, the discussion of the ABCT, the consideration of the arguments and theories presented against the Austrian Business Cycle Theory (ABCT), the identification of the economic theories relevant to the monetary and fiscal policies that are employed to enhance the growth of an economy and to develop a basic understanding of the role of quantitative easing in the macroeconomic working of nation. Literature Review Quantitative Easing is a key monetary policy which has been used over years by the central banks of different nations across the world for the purpose of stimulation of these economies. As per the work of Fujiki (2010), Quantitative Easing is a special kind of monetary policy that is implemented by the central banks in situations in which the existing standard monetary policies used in the country are found to be ineffective in stimulating the economy to achieve the desired levels of growth (Fujiki, 2010). The central banks and governments of different developed and developing economies implement the policies of Quantitative Easing by buying different kind of specific financial assets from the private institutions and commercial banks operating in the country. This results in the increase in the prices of these specific financial instruments and also leads to a decrease in the yields from these financial instruments. Together, these two factors result in the increase in the monetary base within the economic system. Inflation refers to the consistent increase in the prices of products and services in an economy over a particular period of time. Inflation is an important indicator of the economic health and condition of a nation and is largely dependent on the ways in which the central banks of the economy implement the monetary and fiscal policies. The Quantitative Easing policy is one such monetary policy that is known to have visible effects on enhancing the intensity of inflation in the long term period of an economy. Censky (2010) identifies that the Quantitative Easing policy is different from the usual policies of buying and selling the short term government bonds because, while the Quantitative Easing is aimed at increasing the money reserves in the economy, the other policy approach is aimed at maintaining the interbank rates of interest in the nation at a pre decided value (Censky, 2010). Generally, these kinds of expansionary monetary policies are used to support the economy by lowering the short term interest rates in the market. The Quantitative Easing policy, on the other hand, is employed when the short term interest rate in the market becomes zero value or approaches zero value which makes the expansionary monetary policies ineffective in uplifting the economic constructs. Mostly, the Quantitative Easing technique is used to stimulate the economic system by buying assets which have longer maturity period as compared to the short term government floated bonds. This results in the lowering of the long term interest rates in the financial markets and also decreases the yields on these financial instruments so that the yield curve is appropriately maintained. Anderson, Gascon and Yang (2014) argue that the main ground for inflation as caused by the Quantitative Easing can be explained on the basis of the classic equation of exchange derived by Fischer. This equation is stated as MV=PQ2 in which M= Money reserve P= Inflation V= Velocity of money Q= Quantitative Easing. Also, the Quantity theory of money can be used to explain the role of the Quantitative Easing in the process of inflation aggravation, in case of the assumptions that real output is not dependent on the money supply in an economy, velocity of money is stable and that the growth in money is in direct proportion to the growth in P which denotes inflation (Anderson, Gascon and Yang, 2014). The views of some scholars and economists are in line with the ABCT which state that the nature of economic business cycles is such that the use of the Quantitative Easing techniques can cause inflation in the medium to long term scenario. Gagnon, Raskin, Remache and Sack (2011) identify that a major dimension of the Quantitative Easing policy is to ensure that the inflation within an economy does not go below a pre deiced target (Gagnon, Raskin, Remache and Sack, 2011). The ABCT theory also supports the idea that, though the systems of Quantitative Easing are used to ensure that inflation in an economy is maintained at an optimum level, yet there are a number of inherent risks associated with the use of this policy for managing inflation. These risks may include the policy being more effective than desired in the process of controlling the degree of deflation which makes the economy more susceptible to the high level of inflation in the medium to long term because the money supply within the economy is driven up as a long term result of the implementation of this policy. As per the views of Jensen (2012), one of the main reasons as to why the technique of Quantitative Easing is considered as the last and least preferred method for reviving an economy is that the Quantitative Easing has the inherent property of being more effective than necessary in controlling the deflation related factors within a country which often makes the money supply in the economy increase and in turn the inflation level in the economy is also heightened (Jensen, 2012). The Austrian economies also propagated the idea that while the technique of Quantitative Easing cannot be said to be the sole driver of the high level of inflation in an economy, it can act as one of the primary reasons for driving up the inflation level in the economy of the United States and subsequently the other major economies of the world. According to the ABCT theory, the nature of the business cycles would be major factor that would drive up the inflation levels and would be supported in the same by the implementation of the QE policies. Research methodology The research methodology used for the selected study involves the use of an explorative research design which includes mainly secondary research methods. Additionally, both the quantitative and qualitative research designs are adopted for the purpose of gathering and analyzing data in the most relevant and result oriented manner. The research method would be largely oriented towards secondary data collection and quantitative data analysis techniques. The data and information for the research would be collected from the published economic reports, the US Federal Reserve Publications, various academic journals and articles, newspaper publishing, industry reports and international economic institutions like the International Monetary Fund (IMF) would be analyzed and interpreted to answer the research questions in an appropriate and sufficient manner. Findings and analysis The collected secondary data for the research are analyzed and implemented in the most relevant manner such that the research objectives for the study are adequately attained. It is noted that the United States Federal Reserve implemented the first round of Quantitative Easing known as QE 1 in the year 2009 when it was identified that the money reserves in the country were reaching a peak with the value being approximately USD 2.1 trillion. So, the US government started employing the Quantitative Easing technique by buying the corporate bonds, asset backed and mortgage backed securities with the aim to make the economy grow at the desired rate. The US federal bank again announced a second level of Quantitative Easing in the year 2010 in which it bought treasury securities and government bonds which were worth USD 600 billion. Figure 1: US treasury and mortgage backed securities valuation (Source: Anderson, Gascon and Yang, 2014) The Austrian economists predicted that the QE policies implemented by the Federal Reserve would result in massive and uncontrolled levels of inflation in the global economy starting from the economy of the US. However, in the real scenario, it was identified that the QE system implemented by the Federal Reserve in both the years resulted in establishing the economy and boosting the growth of the economy of the US which with time spread to impact the other economies of both the developed and developing countries. The predictions given by the Austrian economists were largely formed on the basis of the traditional Austrian Business Cycle Theory. This theory analyses how the business cycles crop up in the economic constructs. As per this theory, the business cycles in an economy are the results of the excessive growth in the level of bank credits within an economy that is caused by the artificial reduction in the interest rates. The artificial reduction in the interest rates in bank credit is forced by the central banks or the fractional reserve banks function in specific economies. The ABCT has already been much criticized by economists across the globe due to the inherent incomplete nature and the wide number of assumptions taken up in the theory. However, after the latest forecasts of the Austrian economists regarding the QE initiatives being the potential drivers of uncontrollable inflation were proved wrong, the Austrian economic theories were proven to be much lacking in nature for making adequate and appropriate economic forecasts and predictions related to fiscal and monetary policy implementation. The results of the QE policies by the Federal results were starkly different from the predictions made by the Austrian economists. Both the QE1 and the QE2 acted as effective stimulus programs to help the US Federal Reserve to boost the economy by relieving more than USD 49 billion per month in the background of commercial housing and market debt crisis. It can also be identified from the analysis that the Quantitative Easing technique employed by the United States Federal Reserve in both 2009 and 2010 specifically contributed to the reduction of interest rates for the mortgage backed assets and corporate bonds, thereby supporting the extreme price rises of the products and services in the country. Also, the Quantitative Easing employed in both the periods also contributed to the increase in the stock market valuation of the capital markets in the United States of America, in terms of the price earnings ratio for the Dow Jones Index and the Standard and Poor 500 index, added to the investor groups’ expectations regarding higher yields and future inflation growth, increased rates of inflation in the economy, higher rates of employment opportunities creation, and higher growth in the Gross Domestic Product (GDP) and Gross National Product (GNP) of the country. These facts were completely opposite to what the Austrian economists had predicted regarding the results and long term impacts of the QE policy implementation by the Federal Reserve. The Quantitative Easing policy also led to the expansion of the money base in the country which combined with the upturn in the monetary reserves and velocity of money growth can significantly impact the target levels of inflation in the medium to long terms scenarios of the economy (Anderson, 2010). The inflation rates and inflation expectations in the United States remain just above or below the current target rates of inflation which proved the perceptions of the Austrian economists regarding the Quantitative Easing conditions being the aggravators of inflation in the economy to be null and void in the current economic constructs. Thus, in the case of the use of QE policy in the United States of America, significant economic growth was noticed after both the rounds of Quantitative Easing employed in the macro economic situation of the country (Thornton, 2010). These conditions suggested that the QE policy was the most suitable monetary policy that could be used to boost the growth of the economy and thus, nullified the arguments as presented by the economists on the basis of the Austrian Business Cycle Theory (ABCT). As per the views of the Austrian economists, since the Quantitative Easing mechanism does not include a transmission system that can substantially enhance the aggregate demand in an economy. Therefore, after the Quantitative Easing technique is employed, the supply levels increase while the income and savings of the people in the country do not increase. This combination is one of the most potential drivers of high inflation in an economy. The Austrian economists thus argued that this is also one of the prime reasons as to why the implementation of the Quantitative Easing systems in both the years would play a significant role in aggravating the degree of inflation in the global economic systems. Thus, it was established in both the QE 1 and QE 2 implementation cases that though there are some relations between QE and inflation, yet no noticeable profs can be found regarding QE being a driver of inflation because the policy implementation has been carefully managed and implemented by the Federal Reserve to achieve the desired macroeconomic results. It can be said that inflation is an existent monetary phenomenon which has to be controlled and managed in the most efficient and optimal manner by the policy makers and regulators in an economy to ensure the growth of the same. As per the Austrian economists, the Quantitative Easing monetary policy was expected to have played a profound role in driving the levels of inflation in an economy, primarily due to the over excessive limits that this technique sets on the deflation condition in an economy. But in reality, the QE policies acted as significant phenomenon in enhancing the strengths and condition of the US economy. Conclusion Thus, it can be identified from the findings and interpretations of the data collected in the research that both the Quantitative Easing initiatives taken by the Federal Reserve have played a substantial role in uplifting the economic conditions in the country and no substantial arguments can be presented regarding the role of the QE policies in increasing the level of inflation in the global economic systems. The Austrian economists predicted that the QE initiatives would increase the level of inflation in the economy because the Quantitative Easing system has the inherent characteristics that make it a driver of inflation in an economy in the long run. But the predictions made by the Austrian Economists were found to be most in appropriate in the case of the QE policies implemented by the Federal reserve in 2009 and 2010 because they failed to identify the fact that the Federal Reserve was employing suitable strategies to make the Quantitative Easing technique control the deflation level and at the same time was establishing mechanism to ensure that these policies did not support inflation growth in the most influential economy of the world, the United States of America. Thus, in the long term, it was identified that the impacts of the QE policies were positive on the US economy, which in turn also impacted the other economies of the world by excessively controlling the scopes and degrees of economic stagnancy and inflation, thereby leading to a radical increase in economic strengths and growths in the global economy. References Anderson, R. G. (2010). The First U.S. Quantitative Easing: The 1930s. Federal Reserve Bank of St. Louis Economic Synopses. Vol. 17(6), p.186. Anderson, R. G., Gascon, C.S. & Yang. L. (2014). Doubling Your Monetary Base and Surviving: Some International Experience. Federal Reserve Bank of St. Louis Review, Vol. 92(6), pp. 481-505. Censky, A. (2010). QE2: Fed pulls the trigger. Retrieved from http://money.cnn.com/2010/11/03/news/economy/fed_decision/. Fujiki, H. (2010).  Monetary Policy under Zero Interest Rate: Viewpoints of Central Bank Economists. Monetary and Economic Studies. Vol. 14(2), pp.80-84. Gagnon, J., Raskin M., Remache, J. & Sack, B. (2011). The Financial Market Effects of the Federal Reserve’s Large-Scale Asset Purchases. International Journal of Central Banking, Vol. 3(1), p.43. Jensen, G. (2012). QE3 Launched: The Ever Decreasing Effects of Monetary Stimulus. Retrieved from http://www.nasdaq.com/article/qe3-launched-the-ever-decreasing-effects-of-monetary-stimulus-cm174677. Thornton, D. L. (2010). The downside of quantitative easing. Federal Reserve Bank of St. Louis Economic Synopses. Vol. 34 (1), pp.100-110. Read More