Quantitative easing (QE) is an indirect
method of printing of money. In a narrow sense, “printing money” is increasing
the volume of money in circulation i.e. now it is more of electronic money. In
a wider sense, “printing money” is any type of expansionary monetary policy to
stimulate an economy, increase inflation and employment. So, in that wider
sense, reducing interest rates, decreasing liquidity or reserve requirements,
easing collateral requirements and QE are all tools at the disposal of a
central bank.
QE does increase money supply, but it
takes time and may not help if borrowers are not keen to borrow. Why? Business
outlook may look rather bleak or/and banks remain cautious in their lending.
Where the central bank purchases financial
assets from financial institutions, which is almost always government bonds, it
is paid for by creating new central bank reserves. QE therefore simultaneously
increases amount of central bank money and amount of commercial bank money
(deposits in bank accounts). Only the deposits can be spent in the real
economy.
Quantitative easing affects the economy
in several ways:
·
Credit
channel – providing liquidity;
·
Portfolio
rebalancing – private investors turn to other securities;
·
Exchange
rate – leads to weaker currency and improves exports;
·
Fiscal
effect – cheaper for Government to borrow; and
· Signalling
effect – suggests the central bank will take extraordinary measures to
facilitate recovery.
The Federal Reserve (Fed) has been
unstoppable in expanding its balance sheet. It has now reached USD7.04
trillion, because of Covid -19. The Fed has now announced plans to purchase
corporate debts and high yield ETFs. Many corporates are therefore rushing to
raise new capital, knowing that the Fed is there to provide a backstop. What
about moral hazard? What if the companies do not survive the economic turmoil?
Why was QE not effective in boosting
GDP?
The newly created money, as said earlier,
goes into the financial markets— basically, bonds and stocks. The Bank of
England (BoE) estimates that QE boosted bond and share prices by around 20%. In
theory, people who are now wealthier should spend more. However, 40% of the
stock market in the U.K. is owned by the wealthiest 5% of the population. While
most families saw no benefit from QE, the richest 5% of households would have
been better off.
Very little money created through QE in
the U.K. has boosted the real (non-financial) economy. BoE estimates that the
first £ 375 billion of new money created just £23-£28 billion of extra spending
in the real economy (or 1.5-2.0 GDP growth). It is incredibly ineffective. And
it relies on a “trickle down” theory of wealth.
A more effective way to boost the real
economy is for BoE to create money and grant it to the Government and allow it
to spend directly into the economy. This could be for infrastructure or sectors
with high economic linkages that create employment and all the multiplier effects.
What’s stopping a government from doing
so?
Fiscal prudence or prescribed debt
ceilings imposed by various Parliaments. Then you have analysts and economists
raising concerns on the ratio of debt to equity. Reinhart and Rogoff have found
that debt to GDP above 90% impacts negatively growth rate of a country.
In this Covid situation, temporary or limited
exemptions need to be provided where debt to GDP is well below 90%. Otherwise,
there is negative growth and outlook. Private investment or consumption will be
limited hence it is time for the public sector to play the more dynamic role or
catalyst.
References
1.
How
Quantitative Easing Works, Positive Money.
2.
The
Market is Fed, Pankaj C. Kumar, Starbiz Week, Saturday 23 May 2020.
No comments:
Post a Comment