Quantitative easing
Encyclopedia
Quantitative easing is an unconventional monetary policy used by central banks to stimulate the national economy when conventional monetary policy has become ineffective. A central bank buys financial asset
s to inject a pre-determined quantity of money into the economy. This is distinguished from the more usual policy of buying or selling government bond
s to keep market interest rates at a specified target value.
A central bank implements quantitative easing by purchasing financial assets from banks
and other private sector businesses with new electronically created money
. This action increases the excess reserves
of the banks, and also raises the prices of the financial assets bought, which lowers their yield
.
Expansionary monetary policy
typically involves the central bank buying short-term government bonds in order to lower short-term market interest rates (using a combination of standing lending facilities and open market operations). However, when short-term interest rates are either at, or close to, zero
, normal monetary policy
can no longer lower interest rates. Quantitative easing may then be used by the monetary authorities to further stimulate the economy by purchasing assets of longer maturity than only short term government bonds, and thereby lowering longer-term interest rates further out on the yield curve
.
Quantitative easing can be used to help ensure inflation
does not fall below target. Risks include the policy being more effective than intended in acting against deflation, and thereby causing higher inflation, or of not being effective enough (if banks do not loan
out the money).
by raising or lowering its interest rate target for the inter-bank interest rate. A central bank generally achieves its interest rate target mainly through open market operations, where the central bank buys or sells short-term government bonds from banks and other financial institutions. When the central bank disburses or collects payment for these bonds, it alters the amount of money in the economy, while simultaneously affecting the price (and thereby the yield
) for short-term government bonds. This in turn affects the interbank interest rate
s.
If the nominal interest rate
is at or very near zero
, the central bank cannot lower it further. Such a situation, called a liquidity trap
, can occur, for example, during deflation or when inflation is very low. In such a situation, the central bank may perform quantitative easing by purchasing a pre-determined amount of bonds or other assets from financial institutions without reference to the interest rate. The goal of this policy is to increase the money supply
rather than to decrease the interest rate, which cannot be decreased further. This is often considered a "last resort" to stimulate the economy.
Quantitative easing, and monetary policy in general, can only be carried out if the central bank controls the currency
used. The central banks of countries in the Eurozone
, for example, cannot unilaterally expand their money supply, and thus cannot employ quantitative easing. They must instead rely on the European Central Bank
(ECB) to set monetary policy.
has claimed that the central bank adopted a policy with this name on 19 March 2001. However, the Bank of Japan's official monetary policy announcement of this date does not make any use of this expression (or any phrase using "quantitative") in either the Japanese original statement or its English translation. Indeed, the Bank of Japan had for years, including as late as February 2001, claimed that "quantitative easing … is not effective" and rejected its use for monetary policy. Speeches by the Bank of Japan leadership in 2001 gradually, and ex post, hardened the subsequent official Bank of Japan stance that the policy adopted by the Bank of Japan on March 19, 2001 was in fact quantitative easing. This became the established official view, especially after Toshihiko Fukui was appointed governor in February 2003. The use by the Bank of Japan is not the origin of the term quantitative easing or its Japanese original (ryoteki kinyu kanwa). This expression had been used since the mid-1990s by critics of the Bank of Japan and its monetary policy.
Quantitative easing was used unsuccessfully by the Bank of Japan (BOJ) to fight domestic deflation in the early 2000s
. The Bank of Japan has maintained short-term interest rates at close to zero since 1999. With quantitative easing, it flooded commercial bank
s with excess liquidity to promote private lending, leaving them with large stocks of excess reserves
, and therefore little risk of a liquidity shortage. The BOJ accomplished this by buying more government bonds than would be required to set the interest rate to zero. It also bought asset-backed securities
and equities
, and extended the terms of its commercial paper
purchasing operation.
The earliest written record of the phrase and concept of "quantitative easing" has been attributed to the economist Dr Richard Werner
, Professor of International Banking at the School of Management, University of Southampton (UK). At the time working as chief economist of Jardine Fleming Securities (Asia) Ltd. in Tokyo, he coined the expression in 1994 during presentations to institutional investors in Tokyo. It is also, among others, in the title of an article published on September 2, 1995, in the Nihon Keizai Shinbun (Nikkei). According to its author, he used this phrase in order to propose a new form of monetary stimulation policy by the central bank that relied neither on interest rate reductions (which Werner claimed in his Nikkei article would be ineffective) nor on the conventional monetarist policy prescription of expanding the money supply
(e.g., through "printing money", expanding high powered money, expanding bank reserves or boosting deposit aggregates such as M2; all of which Werner also claimed would be ineffective). Instead, Werner argued, it was necessary and sufficient for an economic recovery to boost "credit creation", through a number of measures. He also suggested direct purchases of non-performing assets from the banks by the central bank; direct lending to companies and the government by the central bank; purchases of commercial paper, other debt, and equity instruments from companies by the central bank; and stopping the issuance of government bonds to fund the public sector borrowing requirement, instead having the government borrow directly from banks through a standard loan contract.
, the United Kingdom
and the Eurozone
during the Financial crisis of 2007–2010. Quantitative easing was used by these countries as their risk-free short-term nominal interest rates are either at, or close to, zero. In US, this interest rate is the federal funds
rate. In UK, it is the official bank rate
.
During the peak of the financial crisis in 2008, in the United States the Federal Reserve expanded its balance sheet dramatically by adding new assets and new liabilities without "sterilizing" these by corresponding subtractions. In the same period the United Kingdom also used quantitative easing as an additional arm of its monetary policy in order to alleviate its financial crisis.
The European Central Bank
has used 12-month long-term refinancing operations (a form of quantitative easing without referring to it as such) through a process of expanding the assets that banks can use as collateral that can be posted to the ECB in return for euros. This process has led to bonds being "structured for the ECB". By comparison the other central banks were very restrictive in terms of the collateral they accept: the US Federal Reserve used to accept primarily treasuries (in the first half of 2009 it bought almost any relatively safe dollar-denominated securities); the Bank of England
applied a large haircut
.
During its QE programme, the Bank of England bought gilts from financial institutions, along with a smaller amount of relatively high-quality debt issued by private companies. The banks, insurance companies and pension funds can then use the money they have received for lending or even to buy back more bonds from the bank. The central bank can also lend the new money to private banks or buy assets from banks in exchange for currency. These have the effect of depressing interest yields on government bonds and similar investments, making it cheaper for business to raise capital. Another side effect is that investors will switch to other investments, such as shares, boosting their price and thus encouraging consumption. QE can reduce interbank overnight interest rates, and thereby encourage banks to loan money to higher interest-paying and financially weaker bodies.
The Bank of England
had purchased around £165 billion of assets by September 2009 and around £175 billion of assets by end of October 2010.http://www.bankofengland.co.uk/publications/speeches/2009/speech404.pdf
At its meeting in November 2010, the Monetary Policy Committee
(MPC) voted to increase total asset purchases to £200 billion. Most of the assets purchased have been UK government securities (gilts), the Bank has also been purchasing smaller quantities of high-quality private sector assets. In December 2010 MPC member Adam Posen
called for a £50 billion expansion of the Bank's quantitative easing programme, whilst his colleague Andrew Sentance
has called for an increase in interest rates due to inflation being above the target rate of 2%. In October 2011, the Bank of England announced it would undertake another round of QE, creating an additional £75 billion, bringing the total amount to £275 billion.
The European Central Bank
(ECB) said it would focus efforts on buying covered bonds, a form of corporate debt. It signalled initial purchases would be worth about €60 billion in May 2009.
The Bank of Japan
(BOJ) increased the commercial bank current account balance from ¥5 trillion yen
to ¥35 trillion (approximately US$300 billion) over a 4 year period starting in March 2001. As well, the BOJ tripled the quantity of long-term Japan government bonds it could purchase on a monthly basis. In early October 2010, the BOJ announced that it would examine the purchase of ¥5 trillion (US$60 billion) in assets. This was an attempt to push the value of the yen versus the US dollar down to stimulate the local economy by making their exports cheaper; it did not work. On 4 August 2011 the bank announced a unilateral move to increase the amount from ¥40 trillion (US$504 billion) to a total of ¥50 trillion (US$630 billion). In October 2011 the Bank of Japan expanded its asset purchase program by ¥5 trillion ($66bn) to a total of ¥55 trillion.
, the quantitative easing policies undertaken by the central banks of the major developed countries since the beginning of the late-2000s financial crisis
have contributed to the reduction in systemic risks following the bankruptcy of Lehman Brothers
. The IMF states that the policies also contributed to the improvements in market confidence and the bottoming out of the recession in the G-7 economies in the second half of 2009.
Economist Martin Feldstein
argues that QE2 led to a rise in the stock-market in the second half of 2010, which in turn contributed to increasing consumption and the strong performance of the US economy in late-2010.
In November 2010, a group of conservative Republican
economists and political activists released an open letter to Federal Reserve Chairman Ben Bernanke
questioning the efficacy of the Fed's QE program. The Fed responded that their actions reflected the environment of high unemployment and low inflation.
An increase in money supply has an inflationary effect (as indicated by an increase in the annual rate of inflation). There is a time lag between money 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 the reserves back to higher levels through raising of interest rates or other means, effectively reversing the easing steps taken.
On the other hand, in economies when the monetary demand is highly inelastic with respect to interest rates, or interest rates are close to zero (symptoms which imply a liquidity trap
), quantitative easing can be implemented in order to further boost monetary supply, and assuming that the economy is well below potential (inside the production possibilities frontier), the inflationary effect would not be present at all, or in a much smaller proportion.
Increasing the money supply tends to depreciate a country's exchange rate
s versus other currencies. This feature of QE directly benefits exporters residing in the country performing QE and also debtor
s whose debts are denominated in that currency, for as the currency devalues so does the debt. However, it directly harms creditor
s and holders of the currency as the real value of their holdings decrease. Devaluation of a currency also directly harms importers as the cost of imported goods is inflated by the devaluation of the currency.
The new money 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.
, of the London School of Economics
, has proposed a terminology to distinguish quantitative easing, or an expansion of a central bank's balance sheet, from what he terms qualitative easing, or the process of a central bank adding riskier assets onto its balance sheet:
distinguished the new programme, which he termed "credit easing" from Japanese-style quantitative easing. In his speech, he announced:
Credit easing involves increasing the money supply by the purchase not of government bonds, but of private sector assets such as corporate bonds and residential mortgage-backed securities. When undertaking credit easing, the Federal Reserve increases the money supply not by buying government debt, but instead by buying private sector assets including residential mortgage-backed securities. In 2010, the Federal Reserve purchased $1.25 trillion of mortgage-backed securities (MBS) in order to support the sagging mortgage market. These purchases increased the monetary base in a way similar to a purchase of government securities.
Central banks in most developed nations (e.g., UK, US, Japan, and EU) are forbidden by law to buy government debt directly from the government and must instead buy it from the secondary market. This two-step process, where the government sells bonds to private entities then the central bank buys them, has been called "monetizing the debt" by many analysts. The distinguishing characteristic between QE and monetizing debt is that with QE, the central bank is creating money to stimulate the economy, not to finance government spending. Also, the central bank has the stated intention of reversing the QE when the economy has recovered (by selling the government bonds and other financial assets back into the market). The only effective way to determine whether a central bank has monetized debt is to compare its performance relative to its stated objectives. Many central banks have adopted an inflation target. It is likely that a central bank is monetizing the debt if it continues to buy government debt when inflation is above target, and the government has problems with debt-financing.
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 was 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 (for example, buying federal agency debt securities and mortgage-backed securities). This speech showed that Bernanke was already prepared to prevent deflation and deal with the problem of rates at the zero bound by printing money or its electronic equivalent. This speech led critics to refer to Bernanke as "helicopter Ben"
Other central bankers and economists have referred to "money printing" while discussing monetary policy during QE.
Richard W. Fisher
, president of the Federal Reserve Bank of Dallas
, has said that the US is monetizing debt through QE, referencing the additional $600 billion created for QE2, "For the next eight months, the nation's central bank will be monetizing the federal debt."
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".
action in 1961 known as Operation Twist, The Economist
has posited that a similar restructuring of the supply of different types of debt would have an effect equal to that of QE. Such action would allow finance ministries (e.g., the US Department of the Treasury
) a role in the process now reserved for central banks.
Financial asset
A financial asset is an intangible asset that derives value because of a contractual claim. Examples include bank deposits, bonds, and stocks. Financial assets are usually more liquid than tangible assets, such as land or real estate, and are traded on financial markets....
s to inject a pre-determined quantity of money into the economy. This is distinguished from the more usual policy of buying or selling government bond
Government bond
A government bond is a bond issued by a national government denominated in the country's own currency. Bonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company or country...
s to keep market interest rates at a specified target value.
A central bank implements quantitative easing by purchasing financial assets from banks
Banks
Banks or The Banks may refer to:* Bank, a financial institution- Placenames :Australia* Banks, Australian Capital Territory, a suburb of Canberra...
and other private sector businesses with new electronically created money
Money creation
In economics, money creation is the process by which the money supply of a country or a monetary region is increased due to some reason. There are two principal stages of money creation. First, the central bank introduces new money into the economy by purchasing financial assets or lending money...
. This action increases the excess reserves
Excess reserves
In banking, excess reserves are bank reserves in excess of the reserve requirement set by a central bank. They are reserves of cash more than the required amounts. Holding excess reserves is generally considered costly and uneconomical as no interest is earned on the excess amount...
of the banks, and also raises the prices of the financial assets bought, which lowers their yield
Yield (finance)
In finance, the term yield describes the amount in cash that returns to the owners of a security. Normally it does not include the price variations, at the difference of the total return...
.
Expansionary monetary policy
Expansionary monetary policy
In economics, expansionary policies are fiscal policies, like higher spending and tax cuts, that encourage economic growth. In turn, an expansionary monetary policy is monetary policy that seeks to increase the size of the money supply...
typically involves the central bank buying short-term government bonds in order to lower short-term market interest rates (using a combination of standing lending facilities and open market operations). However, when short-term interest rates are either at, or close to, zero
Zero interest rate policy
The zero interest rate policy is a macroeconomic concept describing conditions with a very low interest rate, such as contemporary Japan and, since December 16, 2008, the United States. It can be associated with slow economic growth....
, normal monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
can no longer lower interest rates. Quantitative easing may then be used by the monetary authorities to further stimulate the economy by purchasing assets of longer maturity than only short term government bonds, and thereby lowering longer-term interest rates further out on the yield curve
Yield curve
In finance, the yield curve is the relation between the interest rate and the time to maturity, known as the "term", of the debt for a given borrower in a given currency. For example, the U.S. dollar interest rates paid on U.S...
.
Quantitative easing can be used to help ensure inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
does not fall below target. Risks include the policy being more effective than intended in acting against deflation, and thereby causing higher inflation, or of not being effective enough (if banks do not loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
out the money).
Process
Ordinarily, a central bank conducts monetary policyMonetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
by raising or lowering its interest rate target for the inter-bank interest rate. A central bank generally achieves its interest rate target mainly through open market operations, where the central bank buys or sells short-term government bonds from banks and other financial institutions. When the central bank disburses or collects payment for these bonds, it alters the amount of money in the economy, while simultaneously affecting the price (and thereby the yield
Yield (finance)
In finance, the term yield describes the amount in cash that returns to the owners of a security. Normally it does not include the price variations, at the difference of the total return...
) for short-term government bonds. This in turn affects the interbank interest rate
Interbank lending market
The interbank lending market is a market in which banks extend loans to one another for a specified term. Most interbank loans are for maturities of one week or less, the majority being overnight. Such loans are made at the interbank rate...
s.
If the nominal interest rate
Nominal interest rate
In finance and economics nominal interest rate or nominal rate of interest refers to the rate of interest before adjustment for inflation ; or, for interest rates "as stated" without adjustment for the full effect of compounding...
is at or very near zero
Zero interest rate policy
The zero interest rate policy is a macroeconomic concept describing conditions with a very low interest rate, such as contemporary Japan and, since December 16, 2008, the United States. It can be associated with slow economic growth....
, the central bank cannot lower it further. Such a situation, called a liquidity trap
Liquidity trap
A liquidity trap is a situation described in Keynesian economics in which injections of cash into an economy by a central bank fail to lower interest rates and hence to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as...
, can occur, for example, during deflation or when inflation is very low. In such a situation, the central bank may perform quantitative easing by purchasing a pre-determined amount of bonds or other assets from financial institutions without reference to the interest rate. The goal of this policy is to increase the money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
rather than to decrease the interest rate, which cannot be decreased further. This is often considered a "last resort" to stimulate the economy.
Quantitative easing, and monetary policy in general, can only be carried out if the central bank controls the currency
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...
used. The central banks of countries in the Eurozone
Eurozone
The eurozone , officially called the euro area, is an economic and monetary union of seventeen European Union member states that have adopted the euro as their common currency and sole legal tender...
, for example, cannot unilaterally expand their money supply, and thus cannot employ quantitative easing. They must instead rely on the European Central Bank
European Central Bank
The European Central Bank is the institution of the European Union that administers the monetary policy of the 17 EU Eurozone member states. It is thus one of the world's most important central banks. The bank was established by the Treaty of Amsterdam in 1998, and is headquartered in Frankfurt,...
(ECB) to set monetary policy.
In Japan
The original Japanese expression for quantitative easing (量的金融緩和, ryōteki kin'yū kanwa), was used for the first time by a Central Bank in the Bank of Japan's publications. The Bank of JapanBank of Japan
is the central bank of Japan. The Bank is often called for short. It has its headquarters in Chuo, Tokyo.-History:Like most modern Japanese institutions, the Bank of Japan was founded after the Meiji Restoration...
has claimed that the central bank adopted a policy with this name on 19 March 2001. However, the Bank of Japan's official monetary policy announcement of this date does not make any use of this expression (or any phrase using "quantitative") in either the Japanese original statement or its English translation. Indeed, the Bank of Japan had for years, including as late as February 2001, claimed that "quantitative easing … is not effective" and rejected its use for monetary policy. Speeches by the Bank of Japan leadership in 2001 gradually, and ex post, hardened the subsequent official Bank of Japan stance that the policy adopted by the Bank of Japan on March 19, 2001 was in fact quantitative easing. This became the established official view, especially after Toshihiko Fukui was appointed governor in February 2003. The use by the Bank of Japan is not the origin of the term quantitative easing or its Japanese original (ryoteki kinyu kanwa). This expression had been used since the mid-1990s by critics of the Bank of Japan and its monetary policy.
Quantitative easing was used unsuccessfully by the Bank of Japan (BOJ) to fight domestic deflation in the early 2000s
Lost Decade (Japan)
The is the time after the Japanese asset price bubble's collapse within the Japanese economy, which occurred gradually rather than catastrophically...
. The Bank of Japan has maintained short-term interest rates at close to zero since 1999. With quantitative easing, it flooded commercial bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
s with excess liquidity to promote private lending, leaving them with large stocks of excess reserves
Excess reserves
In banking, excess reserves are bank reserves in excess of the reserve requirement set by a central bank. They are reserves of cash more than the required amounts. Holding excess reserves is generally considered costly and uneconomical as no interest is earned on the excess amount...
, and therefore little risk of a liquidity shortage. The BOJ accomplished this by buying more government bonds than would be required to set the interest rate to zero. It also bought asset-backed securities
Asset-backed security
An asset-backed security is a security whose value and income payments are derived from and collateralized by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets that are unable to be sold individually...
and equities
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
, and extended the terms of its commercial paper
Commercial paper
In the global money market, commercial paper is an unsecured promissory note with a fixed maturity of 1 to 270 days. Commercial Paper is a money-market security issued by large banks and corporations to get money to meet short term debt obligations , and is only backed by an issuing bank or...
purchasing operation.
The earliest written record of the phrase and concept of "quantitative easing" has been attributed to the economist Dr Richard Werner
Richard Werner
Richard Andreas Werner is a German academic, economist and professor at the University of Southampton.Werner is noted as central bank critic, monetary and development economist and the originator of the term quantitative easing, as well as the expression "QE2" referring to the need to implement...
, Professor of International Banking at the School of Management, University of Southampton (UK). At the time working as chief economist of Jardine Fleming Securities (Asia) Ltd. in Tokyo, he coined the expression in 1994 during presentations to institutional investors in Tokyo. It is also, among others, in the title of an article published on September 2, 1995, in the Nihon Keizai Shinbun (Nikkei). According to its author, he used this phrase in order to propose a new form of monetary stimulation policy by the central bank that relied neither on interest rate reductions (which Werner claimed in his Nikkei article would be ineffective) nor on the conventional monetarist policy prescription of expanding the money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
(e.g., through "printing money", expanding high powered money, expanding bank reserves or boosting deposit aggregates such as M2; all of which Werner also claimed would be ineffective). Instead, Werner argued, it was necessary and sufficient for an economic recovery to boost "credit creation", through a number of measures. He also suggested direct purchases of non-performing assets from the banks by the central bank; direct lending to companies and the government by the central bank; purchases of commercial paper, other debt, and equity instruments from companies by the central bank; and stopping the issuance of government bonds to fund the public sector borrowing requirement, instead having the government borrow directly from banks through a standard loan contract.
After 2007
More recently, similar policies have been used by the United StatesUnited States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, the United Kingdom
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
and the Eurozone
Eurozone
The eurozone , officially called the euro area, is an economic and monetary union of seventeen European Union member states that have adopted the euro as their common currency and sole legal tender...
during the Financial crisis of 2007–2010. Quantitative easing was used by these countries as their risk-free short-term nominal interest rates are either at, or close to, zero. In US, this interest rate is the federal funds
Federal funds
In the United States, federal funds are overnight borrowings by banks to maintain their bank reserves at the Federal Reserve. Banks keep reserves at Federal Reserve Banks to meet their reserve requirements and to clear financial transactions...
rate. In UK, it is the official bank rate
Official bank rate
The official bank rate is the interest rate that the Bank of England charges Banks for secured overnight lending. It is the British Government's key interest rate for enacting monetary policy. It is more analogous to the US discount rate than to the Federal funds rate...
.
During the peak of the financial crisis in 2008, in the United States the Federal Reserve expanded its balance sheet dramatically by adding new assets and new liabilities without "sterilizing" these by corresponding subtractions. In the same period the United Kingdom also used quantitative easing as an additional arm of its monetary policy in order to alleviate its financial crisis.
The European Central Bank
European Central Bank
The European Central Bank is the institution of the European Union that administers the monetary policy of the 17 EU Eurozone member states. It is thus one of the world's most important central banks. The bank was established by the Treaty of Amsterdam in 1998, and is headquartered in Frankfurt,...
has used 12-month long-term refinancing operations (a form of quantitative easing without referring to it as such) through a process of expanding the assets that banks can use as collateral that can be posted to the ECB in return for euros. This process has led to bonds being "structured for the ECB". By comparison the other central banks were very restrictive in terms of the collateral they accept: the US Federal Reserve used to accept primarily treasuries (in the first half of 2009 it bought almost any relatively safe dollar-denominated securities); the Bank of England
Bank of England
The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694, it is the second oldest central bank in the world...
applied a large haircut
Haircut (finance)
In finance, a haircut is a percentage that is subtracted from the market value of an asset that is being used as collateral. The size of the haircut reflects the perceived risk associated with holding the asset...
.
During its QE programme, the Bank of England bought gilts from financial institutions, along with a smaller amount of relatively high-quality debt issued by private companies. The banks, insurance companies and pension funds can then use the money they have received for lending or even to buy back more bonds from the bank. The central bank can also lend the new money to private banks or buy assets from banks in exchange for currency. These have the effect of depressing interest yields on government bonds and similar investments, making it cheaper for business to raise capital. Another side effect is that investors will switch to other investments, such as shares, boosting their price and thus encouraging consumption. QE can reduce interbank overnight interest rates, and thereby encourage banks to loan money to higher interest-paying and financially weaker bodies.
Amounts
The US Federal Reserve held between $700 billion and $800 billion of Treasury notes on its balance sheet before the recession. In late November 2008, the Fed started buying $600 billion in Mortgage-backed securities (MBS). By March 2009, it held $1.75 trillion of bank debt, MBS, and Treasury notes, and reached a peak of $2.1 trillion in June 2010. Further purchases were halted as the economy had started to improve, but resumed in August 2010 when the Fed decided the economy was not growing robustly. After the halt in June holdings started falling naturally as debt matured and were projected to fall to $1.7 trillion by 2012. The Fed's revised goal became to keep holdings at the $2.054 trillion level. To maintain that level, the Fed bought $30 billion in 2–10 year Treasury notes a month. In November 2010, the Fed announced a second round of quantitative easing, or "QE2", buying $600 billion of Treasury securities by the end of the second quarter of 2011.The Bank of England
Bank of England
The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694, it is the second oldest central bank in the world...
had purchased around £165 billion of assets by September 2009 and around £175 billion of assets by end of October 2010.http://www.bankofengland.co.uk/publications/speeches/2009/speech404.pdf
At its meeting in November 2010, the Monetary Policy Committee
Monetary Policy Committee
The Monetary Policy Committee is a committee of the Bank of England, which meets for two and a half days every month to decide the official interest rate in the United Kingdom . It is also responsible for directing other aspects of the government's monetary policy framework, such as quantitative...
(MPC) voted to increase total asset purchases to £200 billion. Most of the assets purchased have been UK government securities (gilts), the Bank has also been purchasing smaller quantities of high-quality private sector assets. In December 2010 MPC member Adam Posen
Adam Posen
Adam S. Posen is an American economist, a member of the Monetary Policy Committee of the Bank of England and a senior fellow at the Peterson Institute for International Economics...
called for a £50 billion expansion of the Bank's quantitative easing programme, whilst his colleague Andrew Sentance
Andrew Sentance
Andrew Sentance is Senior Economic Adviser to PwC, a position he took up in November 2011. He was an external member of the Monetary Policy Committee of the Bank of England from October 2006 to May 2011.-Qualifications:...
has called for an increase in interest rates due to inflation being above the target rate of 2%. In October 2011, the Bank of England announced it would undertake another round of QE, creating an additional £75 billion, bringing the total amount to £275 billion.
The European Central Bank
European Central Bank
The European Central Bank is the institution of the European Union that administers the monetary policy of the 17 EU Eurozone member states. It is thus one of the world's most important central banks. The bank was established by the Treaty of Amsterdam in 1998, and is headquartered in Frankfurt,...
(ECB) said it would focus efforts on buying covered bonds, a form of corporate debt. It signalled initial purchases would be worth about €60 billion in May 2009.
The Bank of Japan
Bank of Japan
is the central bank of Japan. The Bank is often called for short. It has its headquarters in Chuo, Tokyo.-History:Like most modern Japanese institutions, the Bank of Japan was founded after the Meiji Restoration...
(BOJ) increased the commercial bank current account balance from ¥5 trillion yen
Japanese yen
The is the official currency of Japan. It is the third most traded currency in the foreign exchange market after the United States dollar and the euro. It is also widely used as a reserve currency after the U.S. dollar, the euro and the pound sterling...
to ¥35 trillion (approximately US$300 billion) over a 4 year period starting in March 2001. As well, the BOJ tripled the quantity of long-term Japan government bonds it could purchase on a monthly basis. In early October 2010, the BOJ announced that it would examine the purchase of ¥5 trillion (US$60 billion) in assets. This was an attempt to push the value of the yen versus the US dollar down to stimulate the local economy by making their exports cheaper; it did not work. On 4 August 2011 the bank announced a unilateral move to increase the amount from ¥40 trillion (US$504 billion) to a total of ¥50 trillion (US$630 billion). In October 2011 the Bank of Japan expanded its asset purchase program by ¥5 trillion ($66bn) to a total of ¥55 trillion.
QE1, QE2, and QE3
The expression "QE2" became a "ubiquitous nickname" in 2010, usually used to refer to a second round of quantitative easing by central banks. In retrospect, the round of quantitative easing preceding QE2 may be called "QE1". Similarly, "QE3" refers to proposals for an additional round of quantitative easing following QE2.Effectiveness
According to the IMFInternational Monetary Fund
The International Monetary Fund is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world...
, the quantitative easing policies undertaken by the central banks of the major developed countries since the beginning of the late-2000s financial crisis
Late-2000s financial crisis
The late-2000s financial crisis is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s...
have contributed to the reduction in systemic risks following the bankruptcy of Lehman Brothers
Bankruptcy of Lehman Brothers
Lehman Brothers filed for Chapter 11 bankruptcy protection on September 15, 2008. The bankruptcy of Lehman Brothers remains the largest bankruptcy filing in U.S...
. The IMF states that the policies also contributed to the improvements in market confidence and the bottoming out of the recession in the G-7 economies in the second half of 2009.
Economist Martin Feldstein
Martin Feldstein
Martin Stuart "Marty" Feldstein is an economist. He is currently the George F. Baker Professor of Economics at Harvard University, and the president emeritus of the National Bureau of Economic Research . He served as President and Chief Executive Officer of the NBER from 1978 through 2008...
argues that QE2 led to a rise in the stock-market in the second half of 2010, which in turn contributed to increasing consumption and the strong performance of the US economy in late-2010.
In November 2010, a group of conservative Republican
Republican Party (United States)
The Republican Party is one of the two major contemporary political parties in the United States, along with the Democratic Party. Founded by anti-slavery expansion activists in 1854, it is often called the GOP . The party's platform generally reflects American conservatism in the U.S...
economists and political activists released an open letter to Federal Reserve Chairman Ben Bernanke
Ben Bernanke
Ben Shalom Bernanke is an American economist, and the current Chairman of the Federal Reserve, the central bank of the United States. During his tenure as Chairman, Bernanke has overseen the response of the Federal Reserve to late-2000s financial crisis....
questioning the efficacy of the Fed's QE program. The Fed responded that their actions reflected the environment of high unemployment and low inflation.
Risks
Quantitative easing may cause higher inflation than desired if the amount of easing required is overestimated, and too much money is created. On the other hand, it can fail if banks remain reluctant to lend money to small business and households in order to spur demand. Quantitative easing can effectively ease the process of deleveraging as it lowers yields. But in the context of a global economy, lower interest rates may contribute to asset bubbles in other economies.An increase in money supply has an inflationary effect (as indicated by an increase in the annual rate of inflation). There is a time lag between money 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 the reserves back to higher levels through raising of interest rates or other means, effectively reversing the easing steps taken.
On the other hand, in economies when the monetary demand is highly inelastic with respect to interest rates, or interest rates are close to zero (symptoms which imply a liquidity trap
Liquidity trap
A liquidity trap is a situation described in Keynesian economics in which injections of cash into an economy by a central bank fail to lower interest rates and hence to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as...
), quantitative easing can be implemented in order to further boost monetary supply, and assuming that the economy is well below potential (inside the production possibilities frontier), the inflationary effect would not be present at all, or in a much smaller proportion.
Increasing the money supply tends to depreciate a country's exchange rate
Exchange rate
In finance, an exchange rate between two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in terms of another currency...
s versus other currencies. This feature of QE directly benefits exporters residing in the country performing QE and also debtor
Debtor
A debtor is an entity that owes a debt to someone else. The entity may be an individual, a firm, a government, a company or other legal person. The counterparty is called a creditor...
s whose debts are denominated in that currency, for as the currency devalues so does the debt. However, it directly harms creditor
Creditor
A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...
s and holders of the currency as the real value of their holdings decrease. Devaluation of a currency also directly harms importers as the cost of imported goods is inflated by the devaluation of the currency.
The new money 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.
Qualitative easing
Professor Willem BuiterWillem Buiter
Willem Hendrik Buiter Willem Hendrik Buiter Willem Hendrik Buiter (born September 26, 1949]] was a member of the Bank of England's Monetary Policy Committee from June 1997-May 2000. He joined the London School of Economics as a chair in the European Institute in September 2005....
, of the London School of Economics
London School of Economics
The London School of Economics and Political Science is a public research university specialised in the social sciences located in London, United Kingdom, and a constituent college of the federal University of London...
, has proposed a terminology to distinguish quantitative easing, or an expansion of a central bank's balance sheet, from what he terms qualitative easing, or the process of a central bank adding riskier assets onto its balance sheet:
Credit easing
In introducing the Federal Reserve's response to the 2008–9 financial crisis, Fed Chairman Ben BernankeBen Bernanke
Ben Shalom Bernanke is an American economist, and the current Chairman of the Federal Reserve, the central bank of the United States. During his tenure as Chairman, Bernanke has overseen the response of the Federal Reserve to late-2000s financial crisis....
distinguished the new programme, which he termed "credit easing" from Japanese-style quantitative easing. In his speech, he announced:
Credit easing involves increasing the money supply by the purchase not of government bonds, but of private sector assets such as corporate bonds and residential mortgage-backed securities. When undertaking credit easing, the Federal Reserve increases the money supply not by buying government debt, but instead by buying private sector assets including residential mortgage-backed securities. In 2010, the Federal Reserve purchased $1.25 trillion of mortgage-backed securities (MBS) in order to support the sagging mortgage market. These purchases increased the monetary base in a way similar to a purchase of government securities.
Printing money
Quantitative easing has been nicknamed "printing money" by some members of the media, central bankers, and financial analysts. However, central banks state that the use of the newly created money is different in QE. With QE, the newly created money is used for buying government bonds or other financial assets, whereas the term printing money usually implies that the newly minted money is used to directly finance government deficits or pay off government debt (also known as monetizing the government debt).Central banks in most developed nations (e.g., UK, US, Japan, and EU) are forbidden by law to buy government debt directly from the government and must instead buy it from the secondary market. This two-step process, where the government sells bonds to private entities then the central bank buys them, has been called "monetizing the debt" by many analysts. The distinguishing characteristic between QE and monetizing debt is that with QE, the central bank is creating money to stimulate the economy, not to finance government spending. Also, the central bank has the stated intention of reversing the QE when the economy has recovered (by selling the government bonds and other financial assets back into the market). The only effective way to determine whether a central bank has monetized debt is to compare its performance relative to its stated objectives. Many central banks have adopted an inflation target. It is likely that a central bank is monetizing the debt if it continues to buy government debt when inflation is above target, and the government has problems with debt-financing.
Ben Bernanke
Ben Bernanke
Ben Shalom Bernanke is an American economist, and the current Chairman of the Federal Reserve, the central bank of the United States. During his tenure as Chairman, Bernanke has overseen the response of the Federal Reserve to late-2000s financial crisis....
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 was 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 (for example, buying federal agency debt securities and mortgage-backed securities). This speech showed that Bernanke was already prepared to prevent deflation and deal with the problem of rates at the zero bound by printing money or its electronic equivalent. This speech led critics to refer to Bernanke as "helicopter Ben"
Other central bankers and economists have referred to "money printing" while discussing monetary policy during QE.
Richard W. Fisher
Richard W. Fisher
Richard W. Fisher is currently the President and CEO of the Federal Reserve Bank of Dallas, having assumed that post in April, 2005.-Career:...
, president of the Federal Reserve Bank of Dallas
Federal Reserve Bank of Dallas
The Federal Reserve Bank of Dallas covers the Eleventh Federal Reserve District, which includes Texas, northern Louisiana and southern New Mexico....
, has said that the US is monetizing debt through QE, referencing the additional $600 billion created for QE2, "For the next eight months, the nation's central bank will be monetizing the federal debt."
According to economist Robert McTeer
Robert D. McTeer
Robert D. McTeer is an American economist, and has been a fellow at the US National Center for Policy Analysis since January 2007. McTeer is a former president of the Federal Reserve Bank of Dallas, and a former chancellor of the Texas A&M University System....
, former president of the Federal Reserve Bank
Federal Reserve Bank
The twelve Federal Reserve Banks form a major part of the Federal Reserve System, the central banking system of the United States. The twelve federal reserve banks together divide the nation into twelve Federal Reserve Districts, the twelve banking districts created by the Federal Reserve Act of...
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".
Altering debt maturity structure
Based on research reassessing the effectiveness of the US Federal Open Market CommitteeFederal Open Market Committee
The Federal Open Market Committee , a committee within the Federal Reserve System, is charged under United States law with overseeing the nation's open market operations . It is the Federal Reserve committee that makes key decisions about interest rates and the growth of the United States money...
action in 1961 known as Operation Twist, The Economist
The Economist
The Economist is an English-language weekly news and international affairs publication owned by The Economist Newspaper Ltd. and edited in offices in the City of Westminster, London, England. Continuous publication began under founder James Wilson in September 1843...
has posited that a similar restructuring of the supply of different types of debt would have an effect equal to that of QE. Such action would allow finance ministries (e.g., the US Department of the Treasury
United States Department of the Treasury
The Department of the Treasury is an executive department and the treasury of the United States federal government. It was established by an Act of Congress in 1789 to manage government revenue...
) a role in the process now reserved for central banks.
See also
- Economic history of JapanEconomic history of JapanThe economic history of Japan is one of the most studied for its spectacular growth after the Meiji Restoration when it became the first non-European Power and after the Second World War when the island nation rose to become the world's second largest economy....
- Financial crisis of 2007-2010
- Keynesian endpointKeynesian endpointKeynesian endpoint is a phrase coined by PIMCO's Anthony Crescenzi in an email note to clients in June 2010 to describe the point where governments can no longer stimulate and rescue their economies through increased government spending due to endemic levels of pre-existing government debt."Time,...
- Open market operations
- Money creationMoney creationIn economics, money creation is the process by which the money supply of a country or a monetary region is increased due to some reason. There are two principal stages of money creation. First, the central bank introduces new money into the economy by purchasing financial assets or lending money...
- ZIRP
External links
- Credit Easing Policy Tools Interactive chart of the assets on Federal Reserve's balance sheet.
- Deflation: Making Sure "It" Doesn't Happen Here, 2002 speech by Ben Bernanke on deflation and the utility of quantitative easing
- Bank of England - Quantitative Easing
- Bank of England - QE Explained Pamphlet
- Modern Money Mechanics Federal Reserve Document Explaining How Money Is Created
- Quantitative easing explained (Financial Times Europe)
- A Fed Governor Discusses Quantitative Easing Among Other Topics