Quantitative easing (QE)
is a monetary policy whereby a central bank purchases predetermined amounts of government
bonds or other financial assets in order to inject money into the economy to
expand economic activity. Quantitative
easing is considered to be an unconventional form of monetary policy, which is
usually used when inflation is very low or negative, and when standard monetary
policy instruments have become ineffective.
Similar to conventional open-market
operations used to implement monetary policy, a central bank implements
quantitative easing by buying financial assets from commercial banks and other
financial institutions, thus raising the prices of those financial assets and
lowering their yield, while simultaneously increasing the money supply. However, in contrast to normal policy,
quantitative easing involves the purchase of riskier assets (rather than
short-term government bonds) of predetermined amounts at a large scale, over a
pre-committed period of time.
Central banks usually resort to
quantitative easing when their nominal interest rate target approaches or
reaches zero. Very
low interest rates induces a liquidity trap, a situation where people prefer to
hold cash or very liquid assets, given the low returns on other financial
assets. This makes it difficult for interest
rates to go below zero; monetary authorities may then use quantitative easing
to further stimulate the economy rather than trying to lower the interest rate
further.
Quantitative easing can help bring the
economy out of recession and help ensure that inflation does not fall below the
central bank's inflation target. However
QE programmes are also criticized for their side-effects and risks, which
include the policy being more effective than intended in acting against deflation
(leading to higher inflation in the longer term), or not being effective enough
if banks remain reluctant to lend and potential borrowers are unwilling to
borrow. Quantitative easing was undertaken by all major central banks worldwide
following the global financial crisis of 2007–08, and again in response to the COVID-19
pandemic.
Process and Benefits
Standard central bank monetary policies
are usually enacted by buying or selling government bonds on the open market to
reach a desired target for the interbank interest rate. However, if a recession or depression
continues even when a central bank has lowered interest rates to nearly zero,
the central bank can no longer lower interest rates — a situation known as the liquidity
trap. The central bank may then
implement quantitative easing by buying financial assets without reference to
interest rates. This policy is sometimes described as a last resort to
stimulate the economy.
A central bank enacts quantitative
easing by purchasing, regardless of interest rates, a predetermined quantity of
bonds or other financial assets on financial markets from private financial
institutions. This action increases the excess
reserves that banks hold. The goal of this policy is to ease financial
conditions, increase market liquidity, and encourage private bank lending.
Quantitative easing affects the economy
through several channels:
- Credit
channel: By providing liquidity in the
banking sector, QE makes it easier and cheaper for banks to extend loans
to companies and households, thus stimulating credit growth. Additionally,
if the central bank also purchases financial instruments that are riskier
than government bonds (such as corporate bonds), it can also increase the
price and lower the interest yield of these riskier assets.
- Portfolio
rebalancing: By enacting QE, the
central bank withdraws an important part of the safe assets from the
market onto its own balance sheet, which may result in private investors
turning to other financial securities. Because of the relative lack of
government bonds, investors are forced to "rebalance their
portfolios" into other assets. Additionally, if the central bank also
purchases financial instruments that are riskier than government bonds, it
can also lower the interest yield of those assets (as those assets are
more scarce in the market, and thus their prices go up correspondingly).
- Exchange
rate: Because it increases the
money supply and lowers the yield of financial assets, QE tends to
depreciate a country's exchange rates relative to other currencies,
through the interest rate mechanism.
Lower interest rates lead to a capital outflow from a country,
thereby reducing foreign demand for a country's money, leading to a weaker
currency. This increases demand for exports, and directly benefits
exporters and export industries in the country.
- Fiscal
effect: By lowering yields on
sovereign bonds, QE makes it cheaper for governments to borrow on
financial markets, which may empower the government to provide fiscal
stimulus to the economy. Quantitative easing can be viewed as a debt
refinancing operation of the "consolidated government" (the
government including the central bank), whereby the consolidated
government, via the central bank, retires government debt securities and
refinances them into central bank reserves.
- Boosting
asset prices: When a central bank
buys government bonds from a pension fund, the pension fund, rather than
hold on to this money, it might invest it in financial assets, such as
shares, that gives it a higher return. And when demand for financial
assets is high, the value of these assets increases. This makes businesses
and households holding shares wealthier – making them more likely to spend
more, boosting economic activity.
- Signalling
effect: Some economists argue that
QE's main impact is due to its effect on the psychology of the markets, by
signalling that the central bank will take extraordinary steps to
facilitate economic recovery. For instance, it has been observed that most
of the effect of QE in the Eurozone on bond yields happened between the
date of the announcement of QE and the actual start of the purchases by
the ECB.
Effectiveness of QE
The effectiveness of quantitative easing is the subject of an
intense dispute among researchers as it is difficult to separate the effect of
quantitative easing from other contemporaneous economic and policy measures,
such as negative rates.
Former Federal Reserve Chairman Alan
Greenspan calculated that as of July 2012, there was "very little impact
on the economy". The
straightforward reason was that little of the money ostensibly created by QE
ever made it into circulation. Banks and other financial institutions simply
re-deposited it in the Fed. Bank deposits in the Fed increased by nearly $4
trillion during QE1-3, closely tracking Fed bond purchases. The bond purchase
program amounted to little more than an exercise in journal entry bookkeeping
at the Fed. A different assessment has been offered by Federal Reserve Governor
Jeremy Stein, who has said that measures of quantitive easing such as
large-scale asset purchases "have played a significant role in supporting
economic activity".
While the literature on the topic has
grown over time, it has also been shown that central banks' own research on the
effectiveness of quantitative easing tends to be optimistic in comparison to
research by independent researchers, which could indicate a conflict of
interest or cognitive bias in central bank research.
Several studies published in the
aftermath of the crisis found that quantitative easing in the US has
effectively contributed to lower long term interest rates on a variety of
securities as well as lower credit risk. This boosted GDP growth and modestly
increased inflation. A predictable but
unintended consequence of the lower interest rates was to drive investment
capital into equities, thereby inflating the value of equities relative to the
value of goods and services, and increasing the wealth gap between the wealthy
and the working class.
In the Eurozone, studies have shown that
QE successfully averted deflationary spirals in 2013-2014, and prevented the
widening of bond yield spreads between member states. QE also helped reduce bank lending cost. However, the real effect of QE on GDP and
inflation remained modest and very heterogeneous depending on methodologies
used in research studies, which find on GDP comprised between 0.2% and 1.5% and
between 0.1 and 1.4% on inflation. Model-based studies tend to find a higher
impact than empirical ones.
Risks and Side-Effects of QE
Quantitative easing may cause higher inflation than desired if the
amount of easing required is overestimated and too much money is created by the
purchase of liquid assets. On
the other hand, QE can fail to spur demand if banks remain reluctant to lend
money to businesses and households. Even then, QE can still ease the process of
deleveraging as it lowers yields. However, there is a time lag between monetary
growth and inflation; inflationary pressures associated with money growth from
QE could build before the central bank acts to counter them. Inflationary risks are mitigated if the
system's economy outgrows the pace of the increase of the money supply from the
easing. If production in an economy
increases because of the increased money supply, the value of a unit of
currency may also increase, even though there is more currency available. For
example, if a nation's economy were to spur a significant increase in output at
a rate at least as high as the amount of debt monetized the inflationary
pressures would be equalized. This can only happen if member banks actually
lend the excess money out instead of hoarding the extra cash. During times of high economic output, the
central bank always has the option of restoring reserves to higher levels
through raising interest rates or other means, effectively reversing the easing
steps taken.
Economists such as John Taylor believe
that quantitative easing creates unpredictability. Since the increase in bank
reserves may not immediately increase the money supply if held as excess
reserves, the increased reserves create the danger that inflation may
eventually result when the reserves are loaned out.
QE benefits debtors, since the interest
rate has fallen, meaning there is less money to be repaid. However, QE directly harms creditors
as they earn less money from lower interest rates. Devaluation of a currency also directly harms
importers and consumers, as the cost of imported goods is inflated by the
devaluation of the currency.
Impact on savings and pensions
In the European Union, World Pensions
Council (WPC) financial economists have also argued that artificially low government bond interest rates
induced by QE will have an adverse impact on the underfunding condition of
pension funds, since "without returns that outstrip inflation, pension
investors face the real value of their savings declining rather than ratcheting
up over the next few years".
In addition to this, low or
negative interest rates create disincentives for saving. In a way this is an intended effect, since QE
is intended to spur consumer spending.
Effects on climate change
In Europe, central banks operating
corporate quantitative easing (i.e. QE programmes that include corporate bonds)
such as the European Central Bank or the Swiss National Bank, have been
increasingly criticized by NGOs for not taking into account the climate impact
of the companies issuing the bonds. In
effect, Corporate QE programmes are perceived as indirect subsidy to polluting
companies. The European Parliament has also joined the criticism by adopting
several resolutions on the matter, and has repeatedly called on the ECB to
reflect climate change considerations in its policies.
Central banks have usually responded by
arguing they had to follow the principle of "market neutrality" and
should therefore refrain from making discretionary choices when selecting bonds
on the market. The notion that central banks can be market neutral is
contested, as central banks always make choices that are not neutral for
financial markets when implementing monetary policy.
However, in 2020, several top level ECB
policymaker such as Christine Lagarde, Isabel Schnabel, Frank Elderson and
others have pointed out the contradiction in the market neutrality logic. In
particular, Schnabel argued that "In the presence of market failures,
market neutrality may not be the appropriate benchmark for a central bank when
the market by itself is not achieving efficient outcomes."
Since 2020, several central banks
(including the ECB, Bank of England and the Swedish central banks) have
announced their intention to incorporate climate criteria in their QE
programmes. The Network for Greening the
Financial System has identified different possible measures to align central
banks' collateral frameworks and QE with climate objectives.
Increased income and wealth inequality
Critics frequently point to the
redistributive effects of quantitative easing. For instance, British Prime
Minister Theresa May openly criticized QE in July 2016 for its regressive
effects: "Monetary policy – in the form of super-low interest rates and
quantitative easing – has helped those on the property ladder at the expense of
those who can't afford to own their own home." Dhaval Joshi of BCA Research wrote that
"QE cash ends up overwhelmingly in profits, thereby exacerbating already
extreme income inequality and the consequent social tensions that arise from
it". Anthony Randazzo of the Reason
Foundation wrote that 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".
Those criticisms are partly based on
some evidence provided by central banks themselves. In 2012, a Bank of England
report showed that its quantitative easing policies had benefited mainly the
wealthy, and that 40% of those gains went to the richest 5% of British
households.
In May 2013, Federal Reserve Bank of
Dallas President Richard Fisher said that cheap money has made rich people
richer, but has not done quite as much for working Americans.
Answering similar criticisms expressed
by MEP Molly Scott Cato, the President of the ECB Mario Draghi once declared:
Some of these policies may, on the one
hand, increase inequality but, on the other hand, if we ask ourselves what the
major source of inequality is, the answer would be unemployment. So, to the
extent that these policies help – and they are helping on that front – then
certainly an accommodative monetary policy is better in the present situation
than a restrictive monetary policy.
In July 2018, the ECB published a study showing
that its QE programme increased the net wealth of the poorest fifth of the
population by 2.5 percent, compared with just 1.0 percent for the richest
fifth. The study's credibility was however contested.
International spillovers for BRICs and
emerging economies
Quantitative easing (QE) policies can have a profound effect on Forex
rates, since it changes the supply of one currency compared to another. For instance, if both the US and Europe
are using quantitative easing to the same degree then the currency pair of
US/EUR may not fluctuate. However, if the US treasury uses QE to a higher
degree, as evidenced in the increased purchase of securities during an economic
crisis, but India does not, then the value of the USD will decrease relative to
the Indian rupee. As a result, quantitative
easing has the same effect as purchasing foreign currencies, effectively
manipulating the value of one currency compared to another.
BRIC countries have criticized the QE
carried out by the central banks of developed nations. They share the argument
that such actions amount to protectionism and competitive devaluation. As net exporters whose currencies are partially
pegged to the dollar, they protest that QE causes inflation to rise in their
countries and penalizes their industries.
In a joint statement leaders of Russia,
Brazil, India, China and South Africa, collectively BRICS, have condemned the
policies of western economies saying "It is critical for advanced
economies to adopt responsible macro-economic and financial policies, avoid
creating excessive liquidity and undertake structural reforms to lift
growth" as written in the Telegraph.
According to Bloomberg reporter David
Lynch, the new money from quantitative easing could be used by the banks to
invest in emerging markets, commodity-based economies, commodities themselves,
and non-local opportunities rather than to lend to local businesses that are
having difficulty getting loans.
Moral hazard
Another criticism prevalent in Europe is
that QE creates moral hazard for governments. Central banks’ purchases of
government securities artificially depress the cost of borrowing. Normally,
governments issuing additional debt see their borrowing costs rise, which
discourages them from overdoing it. In particular, market discipline in the
form of higher interest rates will cause a government like Italy's, tempted to
increase deficit spending, to think twice. Not so, however, when the central
bank acts as bond buyer of last resort and is prepared to purchase government
securities without limit. In such circumstances, market discipline will be
incapacitated.
Reputational risks
Richard W. Fisher, president of the Federal
Reserve Bank of Dallas, warned in 2010 that QE carries "the risk of being
perceived as embarking on the slippery slope of debt monetization. We know that once a central bank is perceived
as targeting government debt yields at a time of persistent budget deficits,
concern about debt monetization quickly arises." Later in the same speech, he stated that the
Fed is monetizing the government debt: "The math of this new exercise is
readily transparent: The Federal Reserve will buy $110 billion a month in
Treasuries, an amount that, annualized, represents the projected deficit of the
federal government for next year. For the next eight months, the nation's
central bank will be monetizing the federal debt."
Ben Bernanke remarked in 2002 that the
US government had a technology called the printing press (or, today, its
electronic equivalent), so that if rates reached zero and deflation threatened,
the government could always act to ensure deflation was prevented. He said,
however, that the government would not print money and distribute it
"willy nilly" but would rather focus its efforts in certain areas
(e.g., buying federal agency debt securities and mortgage-backed securities).
According to economist Robert McTeer,
former president of the Federal Reserve Bank of Dallas, there is nothing wrong
with printing money during a recession, and quantitative easing is different
from traditional monetary policy "only in its magnitude and
pre-announcement of amount and timing".
https://en.wikipedia.org/wiki/Quantitative_easing
See also the Daily Quiddity entry for December 19, 2013.