Quantitative Easing - Essay Example

Quantitative Easing Name Institution Lecturer Course Date Introduction According to Stewart (2012), Quantitative easing is one of the monetary policies that are employed by central banks of different economies in order to correct financial problem in times when other means of monetary policies have failed to solve the financial problems (Stewart, 2012, p. 373). This means that the quantitative easing is an unconventional monetary policy that is used by central banks of different countries in the world in order to boost their economies. In this form of monetary policy, the central banks are able to buy the assets of some of the commercial banks that operate in its jurisdiction and other financial institutions. However, the central banks are only allowed to buy a specified amount of assets in order to increase its own financial and monetary base so that it can be able to lower the yields of the acquired financial assets (Joyce et al., 2012, p. F271). The quantitative easing can be distinguished from ordinary purchase of bonds and securities in that the buying and selling of bonds is aimed at keeping interest rates of the commercial banks at a specified rate which is targeted by the central bank in order to stabilize the economy. On the other hand, quantitative easing is implemented at a time when the use of interest rates is failing and the rates are approaching the zero mark. Although the policy has been used by different central banks especially those of developed economies, critics have raised concerns on the use of this policy (Borio & Disyatat, 2010, p. 77). This means that the policy may have its strength and weaknesses. This paper explores the quantitative easing as a policy and aims at determine as to whether quantitative easing really works in stimulating economies in areas where other monetary policies are ineffective. Quantitative Easing and the Bank of Japan In order to resolve debt crisis in different parts of the world, the quantitative easing had been used in different countries. However, the use of these unconventional monetary policies has been faced with a lot of criticism. In Europe, the European central bank that endorsed the use of quantitative is easing in order to boost its economy after the conventional monetary policies had failed. According to Baba et al (2005), the use of this policy attracted different reactions. Another economy that adopted the use of quantitative easing is the bank of Japan that observed different effects of the unconventional monetary policy. In fact the use of quantitative easing in Japan has seen its initiation to its exits hence it can be said that the bank of Japan has seen a full cycle of the experience in quantitative easing. Worried about the increasing deflation in Japan, the bank of Japan decided to use quantitative easing and switched from the targeting the uncollateralized rates that targeted the current balances that were in excess. Hence in 2001, the bank of Japan raised the targeted for reserve balances several times by maintain an adequate supply of the liquidity and the current account balances. In addition, the bank of Japan aims ant increasing the purchase of government bonds in order to implement the quantitative easing. According to Stewart (2012), the bank of Japan continued to implement the program from 2002 to 2005; it recorded a growth in its economy. In addition, there was a decline in the rate of unemployment in Japan as indicated in figure 1. However, the use of quantitative easing was ended in March 2006. Although the bank had projected a growth of inflation above zero that never happened. The quantitative easing was later reintroduced in 2008. From the bank of Japan experience, one is able to see that the use of quantitative erasing had a combined effect. That is to say, the policy did work to some extent and to some extent it failed. Although the programme resulted to an increase in GDP growth, the output gap was narrow. In addition, the inflation rate was never above the zero mark and the wage growth was not sustainable as shown in figure 2. However, one can argue that the bank of Japan was not committed to the policy and took action too late. Moreover, the impact of assets by the bank of Japan was too modest to make the quantitative easing a success (Stewart, 2012, p.374). Figure 1: Japanese unemployment rate and capacity utilization (Stewart, 2012, p 375). Figure 2: Japanese quantitative easing and the economy (Stewart, 2012, p, 375). Quantitative easing in America and Europe The use of quantitative easing also had different effects on the American economy when it was adopted. The result of the financial crisis in the United States of America resulted to the implementation of a financial program that was more or similar to the quantitative easing. Although the program was not names as the quantitative easing since the Fed chairman was avoiding the term, the programme was aimed at buying securities and wanted to differentiate the quantitative easing version of the United States from that of the bank of Japan. Quantitative easing was introduced in late 2008 when the world was experiencing a global financial crisis. In order to implement the programme, the Feb initiated the purchase of US$100bn agency debt and mortgage backed securities worth US$500bn. By March the following year the fed had increased the purchase of agency debts. The second phase of the quantitative easing in the United States was initiated in 2010 which was aimed at buying longer dated treasuries. Moreover, by 2011 September, the feds introduced the Twist in order to increase the purchase of securities. The net effect of the quantitative easing was about 40bp for the first phase and 120bp for the second phase (Swanson, 2011, p. 155). However, these figures did not reflect a big difference of the convectional policies as it was expected. However, it managed to reduce the Feds Funds. This means that the introduction of the quantitative easing had considerable effects in the United States of America (Stewart, 2012, p. 378). The bank of England introduced the use of quantitative easing by purchasing the United Kingdom debts also called gilts. The main aim was to inject more money in the economy and increase the nominal GDP growth and as well as increase the chances of increasing inflation objectives. In its implementation, the bank of England purchase GB£200bn by February 2010. When the bank announced a purchase in gilts there was an increase in gilts yields as indicated in figure 3. Figure 3: historical chart of 10-year gilt yields (Stewart, 2012, p, 370). This was an equivalent of 14 percent of the united kingdom GDP. The bank of England had calculated that the programme will be able to lower the gilt yield by 100bp. This means that the quantitative easing had an effecting in easing the financial burden on the economy by purchase of the debts. Although the Fed had plans to reduce the purchase of bonds, some argue that it is good for the United States economy for it to continue with the programme of quantitative easing. This is because economists claim that ending the programme that most have not realized its benefits is premature. In addition, the Feds policies have managed to recover the market from recession, there is still high unemployment rate in the country. In addition, the quantitative easing and other monetary policies have not been able to boost the wages of the average workers of the United States of America. There has been a concern that the continued purchase of bonds through the quantitative easing by the Feds may result to assets bubbling that may result into recession. What can be learnt from the use of quantitative easing in the United States is that, the policy just like the other convectional monetary policies is not effective in reducing unemployment t and boosting the economy. This is to say that quantitative easing has not done any economic wonders and there is a lot to improve on its implementation since economic growth rate is still low. Therefore the experience from different countries especially united kingdom, Japan and the United States, one is able to come up with different effects of quantitative easing (Stewart, 2012, p. 379). According to Tempelman (2012), Quantitative easing affects the price of assets using different channels as indicated in figure 4. Figure 4: channels of impact of the bank of England’s gilts purchase on domestic demand (Joyce et al, 2012, p. F278). The use of the quantitative easing in Japan signaled the determination of the bank of Japan to keep short rates unchanged especially during the period in which the quantitative easing programme was in effect. This was aimed at lowering the market rates. In addition, the quantitative easing can be channeled through lowering interest rates in order to stimulate the economy directly. The implementation of quantitative easing by the United States, Japan and United Kingdom demonstrated different effects of the policy. The quantitative easing has an effect on domestic economy in that it enabled the softening of the dollar through reduction of risks in the euro zone as it helped the euro to appreciate. Emerging markets outside United States refer to the quantitative easing as one that has unwelcoming effects in that it pushes their currents upwards. For example, the adoption of the quantitative easing in the United States had an effect in the Brazilian currency in what the governor of Brazilian central bank termed it as currency war. In addition, the rise in oil prices during the implementation of the second phase of quantitative easing is attributed to the policy. This means that, the second phase of the quantitative easing in the United States resulted in increased prices and inflationary pressures (Tempelman, 2012, p. 5). Risks of Quantitative Easing The existence of large forms of quantitative easing means that there are a number of risks associated with the adoption and implementation of quantitative easing as a way of correcting financial problems in an economy. These effects are felt either to the financial market directly or through the effects quantitative easing has on the economy to the financial markets. The quantitative easing may not work in all economies depending on how the central bank of that economy implements it. This was evident in the case of Japan where the bank of Japan implemented quantitative easing which was later ended since it was seen as not effective enough to reduce economic challenges such as unemployment (Baba et al, 2005, p 69). Hence, quantitative easing may not have the desired effects for a number of reasons. First, the quantitative easing may not work well for a number of reasons. Firstly, the issue in the economy may be deeply rooted such that the implementation of the policy may not be able to solve it. This was seen in Japan where the deflation was more rooted in the economy such that when the quantitative easing was adopted it had no major effects. This means that for a county’s central bank to have positive effects on quantitative easing, the policy should be implemented in the initial stages of the financial problem. In addition, the scale of the quantitative easing that was implemented in Japan was too small compared to the magnitude of the deflation. According to Joyce et al (2011), the subsequent intervention by the bank of England, and the Feds were some of the massive interventions. Secondly, the actions that accompany the quantitative easing may not be credible enough. This may results into a failure in changing the expectations of the market. Thirdly, the use of other monetary polices in addition to the quantitative easing may not necessarily have any support on the quantitative easing. For example, the United States implemented a multifaceted approach that an interest rate commitment as well as the quantitative easing (Stewart, 2012, p. 382). Heather (2012) argues that the quantitative easing may also distort the market economy of the country. This is because the models that are used in the implementation of quantitative easing in quantifying, measuring and managing market risks may fail to work once the policy is ended. For example, the potential for a decline in market prices may be underestimated. In addition, the quantitative easing has distorted the foreign exchange market and economic structure as witnessed in Japan (Figure 5). Figure 5: The Fed Balance sheet This can also result in a distortion of the monetary policy settings resulting into capitalism and protectionism. This means that the effect of quantitative easing on the foreign exchange market results in a negative effect on other markets. For example, the Fed quantitative easing had an effect on the US Dollar which is used as a peg and as a quasi-peg by other countries. Although other countries have the choice to follow their exchange rates to avoid the effects of the policy, this move is not supported by many (Borio & Disyatat, 2010, p. 55). Hence, any kind of effect that distorts the market also distorts the price signal of the existing real economy. This will lead to a potential misallocation of resources such that it leads to many resources directed towards the public sector at the expense of the private sector. This is because the quantitative easing works towards purchasing of the government debts. When the cost of funding is lowered and reducing the net government debt by purchasing of the debt, such as the case with the bank of England which purchased the gilts that were almost equivalent to the gilts issued in the financial year 2009/2010 has an upward reduction on the yields of affected governments. Hence, quantitative easing may reduce the different incentives to a particular government in order to spell out financial adjustments. Therefore, central banks that implement t the quantitative easing are likely to suffer moral hazards when they buy the government debt (Stewart, 2012, p. 385). According to Gagnon et al (2011), the failure by the quantitative easing adopted by different central banks highlights a number of issues. The central banks that implemented the quantitative easing underestimated the power of the traditional monetary policies. In addition, they overestimated the capability of the policy as a new monetary policy in doing well. What they failed to understand is that there is no monetary policy that is able to can train people, create jobs and change laws. This means that, central banks should not focus on new monetary policies at the expense of traditional policies. In addition, there are some central banks that rely too much on traditional policies (Mortimer-Lee, 2012, p. 374). Hence, the respect accorded to these conventional monetary policies make the quantitative easing ineffective. Therefore, inn order to adopt the quantitative easing, central banks should go an extra mile in doing more analysis in order to prevent the scenarios of Japan and United States (Baba et al, 2005, p 50). Conclusion Quantitative easing is an unconventional monetary policy where the central banks purchase the government dents and assets in situations where the interest rates are approaching zero. There are different breeds of quantitative easing which were initiated in Japan, United States and Europe. All different forms of quantitative easing were adopted since there was a failure in conventional monetary policies as expected by policymakers. Although the policy has been used by different central banks especially those of developed economies, critics have raised concerns on the use of this policy. The adoption of the policy in jape and United States was not successful and was not able to reduce the financial challenges. This is because the policy is associated with a number of risks which should be addressed before implementing the policy. Being a new policy, banks should be able to take the risks in order to establish whether the policy is effective or not. Therefore, as much as the quantitative easing is a new idea in monetary policies, central banks all over the world are in a good position to do more in order to improve it. This is in hope that with time the banks will be able to reduce the risks and be able to manage them effectively. References Baba, N., Nishioka, S., Oda, N., Shirakawa, M., Ueda, K. and Ugai, H 2005. Japan’s deflation, problems in the financial system, and monetary policy. Monetary and Economic Studies, Vol. 23, No. 1, pp. 47– 111. Borio, C. & Disyatat, P 2010. Unconventional monetary policies: An appraisal. The Manchester School, Vol. 78, No. S1, pp. 53– 89. 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. 7, no.10, pp. 3–43 Joyce, M., Miles, D., Scott, A., & Vayanos, D 2012. Quantitative Easing and Unconventional Monetary Policy-An Introduction. Economic Journal, vol.122, no. 564, pp. F271-F288. Joyce, M., Tong, M. and Woods, R 2011. The United Kingdom’s quantitative easing policy: Design, operation and impact. Bank of England Quarterly Bulletin, Vol. 51, No. 3, pp. 200– 212. Heather, M 2012. Quantitative Easing - Unabridged Guide. Newstead: Emereo Pty Limited Mortimer-Lee, P 2012. The Effects and Risks of Quantitative Easing. Journal of Risk Management in Financial Institutions, vol.5, no. 4, pp.372-389 Stewart, H 2012. The effects and risks of quantitative easing. Journal of Risk Management in Financial Institutions, Vol. 5, pp.4372–389. Swanson, E 2011. Let’s Twist again: A high-frequency event-study analysis of operation Twist and its implications for QE2. Brookings Papers on Economic Activity, Vol. 42, No. 1, pp. 151–207. Templeman, J 2012. Against Quantitative Easing by the European Central Bank. Financial Analysts Journal, pp. 4-6 Read More