Quantitative Easing
Quantitative Easing
Quantitative easing (QE) is a fiscal policy designed to stimulate the economy in periods of recession. The basic premise of QE involves the creation of new money. It works as follows: the Central Bank buys government bonds and similar low-risk assets from investors. Subsequently, the Central bank credits the bank account of the investor, essentially creating a new money supply. As a result of these large-scale asset purchases, the price of the bond goes up and the yield of the bond decreases. This enables the treasury to raise government debt by issuing new bonds at a lower interest rate. QE encourages investors to reallocate assets from safe government bonds to riskier assets such as shares, real estate or commodities. In addition, QE also encourages consumers and businesses to increase their debt load to finance investments and consumption. On September the 13th 2008, in the face of a major international financial crisis, the US Federal Reserve announced that QE would come into effect. This would be the first of three rounds of QE. It was a bold and unprecedented move and quickly became a controversial policy debated heavily among economists and laymen alike. Many began to theorize about the reverberations of such a policy and if such a policy would even work in the first place. This article will address the repercussions of this controversial policy as well as the benefits.
Did QE work or did it merely exacerbate the problem? When the policy was introduced in September of 2008, QE was heavily scrutinized. Many believed these measures were short term solutions and that they would exacerbate the problem in the long term. In hindsight, many economists claim that QE reduced the risk of deepening the recession or a full-scale depression, by staving off deflation and boosting the GDP. The International Monetary Fund (IMF), for instance, claims that QE policy “contributed to the reduction in systemic risks following the bankruptcy of Lehman Brothers” during the financial crisis. The IMF concluded that QE1 (the first round of QE) led to “market confidence” which eventually allowed the economy to rebound in a major way. Many QE supporters cite the following graph as evidence for the effectiveness of QE as evidenced by a rebound in earnings multiples, reflecting a return of investor confidence.
On the flip side, economists claim that QE has created long term problems akin to “kicking the can down the road.” Critics cite inflation as a major side effect of QE, as an increase in money supply chases the same amount of goods and services. Many also fear that when the central bank decides it needs to unwind QE by selling the bonds it had acquired, bond prices will crash and yields spike as a result.
There is also concern that QE has exacerbated wealth inequality. The crux of this argument is that QE benefits individuals who are already invested. The value of their portfolios increases as bond prices rise and earnings multiples improve. "[QE] is fundamentally a regressive redistribution program that has been boosting wealth for those already engaged in the financial sector or those who already own homes, but passing little along to the rest of the economy, it is a primary driver of income inequality," says Economist Anthony Randazzo. According to the Bank of England’s report released in 2012, the QE program in the UK had boosted the value of stocks and bonds by 26 per cent, or about $970 billion. It said that about 40 per cent of those gains went to the richest 5 per cent of British households.
Many also liken QE to what is called “Debt Monetization”. Debt monetization is a process through which the government can nullify its debt. The government will issue debt through bonds and the Central Bank (also a government entity) will buy those bonds from the government. Critics also regard the lack of a real economic “boom” which is not uncommon after major recessions, as a testament to the questionable efficacy of QE. The graph below illustrates how the actual GDP in the US has lagged the potential GDP after the recession.
When QE was instituted back in September of 2008 the policy’s intention was to prevent a deepening of the recession. The last round of QE (QE3) ended in October of 2014 and by then it seemed to have fulfilled its purpose, but at what cost? QE was and still is an extremely controversial policy and it’s repercussions remain a heavily debated topic. Below is a list of questions to be considered. If you would like to contribute to the conversation, please comment with your thoughts and ideas.
Did the government overreach when making this type of aggressive, untested fiscal policy?
Does the Central Bank deserve credit for the prevention of a deeper recession or depression?
Does QE negatively affect the economy today? If so what can be done to mitigate against these issues?
Please also post your feedback on this article and suggest ideas for other topics you would like to see discussed in this format.
Sources:
https://www.cnbc.com/id/49031991
https://www.imf.org/external/pubs/ft/spn/2009/spn0927.pdf
https://www.nytimes.com/2009/01/11/business/worldbusiness/11iht-views12.1.19248009.html
