Quantitative easing
From FXPedia
Quantitative easing is unconventional monetary policy used once interest rates fall to zero, often in an effort to counter deflation. Its effect is felt through the increased quantity of credit provided by central banks and governments, rather than the reduced cost of credit through lower interest rates. [1]
Quantitative Easing in Japan
Quantitative easing was a temporary monetary policy adopted by the Bank of Japan in March 2001. The Bank used a series of open market operations conducted by the Bank aimed at increasing the money supply and reducing long-term interest rates. An increased current account balance (including excess reserves) was adopted as the Bank’s main operating target, instead of setting the uncollateralized overnight (O/N) rate in the call market. By increasing its current account balance, the Bank could introduce more liquidity into the markets by purchasing long-term Japanese government bonds (JGBs) and other money market instruments held by commercial banks. With commercial banks parking their excess reserves at the Bank, effective interest rates for the interbank market could remain at or near zero, thereby encouraging lending.
Under quantitative easing, reserves in the banking system to support bank lending increased from the required 5 trillion yen to nearly 35 trillion yen, and effective interest rates remained at or near zero. By the end of 2005, the CPI inflation rate started showing positive values on a sustained basis. Deflationary pressures appeared to have been overcome, so the Bank terminated its quantitative easing policy in March 2006.
It should be noted there were several extenuating circumstances unique to the Japanese situation: large personal and institutional savings (with a limited amount of overleveraged personal and corporate debt), and a localized recession (allowing for a gradual decline in the yen that fueled external demand for its products).
Quantitative Easing in 2008
Quantitative easing was proposed by various economists in the fall of 2008 as one method to address the global liquidity crisis. [2]
We typically think of interest rate cuts as the standard response when the goal is to increase spending in a shrinking economy, but this has already been tried by the G7 central banks with only limited success, as they now approach a zero-bound situation where they are unable to make further cuts. At 0.25% and 0.1% respectively, the U.S. and Japan are basically at zero percent now and Switzerland is not far behind at 0.5 %. Further rate cuts are also expected soon in Canada and England, which should bring both countries within the 1% range.
With interest rate cuts off the table as a means to kick-start the economy, various central banks have started adopting quantitative easing policies. Quantitative easing is specifically intended to increase spending during times of tight credit and a growing reluctance of consumers to part with their cash in the face of uncertainly in the markets and frightening prospects on the job front. Policymakers fear a serious case of deflation if consumers cannot be convinced to spend.
Quantitative easing works by making more money available to the commercial banks and other lending institutions, thereby increasing the liquidity within the system. Interest rates cannot fall any further, but the central banks can continue to shovel money into the economy and with all this cheap money floating around, someone is bound to spend it, right? Well, that’s the theory at least.
There are concerns over whether quantitative easing will work. The U.S. in particular has been following a policy of quantitative easing for a year now starting when the Fed introduced the Term Auction Facility (TAF) last December. TAF was designed to provide more funds to the American banking system, and the more recent moves by the Treasury to fund the financial sector to the tune of $700 billion and even the bail-out of GM and Chrysler are all elements of quantitative easing. The Fed's balance sheet has soared from below $900 billion to more than $2 trillion, and is set to grow further [3], but at the close of 2008 there is still no evidence that these initiatives are working. It remains an open question whether governments and central banks can continue to pursue aggressive quantitative easing policies given the large deficits already existing in many G7 economies.
Related
For Further Reading
- Japanese monetary policy: 1998-2005 and beyond, Takatoshi Ito
- Bank of Japan, Japan’s Open Market Operations under the Quantitative Easing Policy
- Trying to Make Sense of the Bank of Japan’s Monetary Policy since the Exit from Quantitative Easing, Kazuo Ueda, University of Tokyo, December 2007
- Easing Out of Quantitative Easing, Richard Koo
- Quantitative Easing by the Bank of Japan, FRBSF Economic Letter, 2001-31; November 2, 2001
References
- ↑ "Ground zero," The Economist, Dec 18th 2008
- ↑ Why we should aim for quantitative easing, The Economists Forum, Financial Times, Graham Turner
- ↑ "Ground zero," The Economist, Dec 18th 2008
