Introduction of
Quantitative Easing
August 2012
What is Quantitative Easing?
• Quantitative easing (QE) is an unconventional
monetary policy used by central banks to
stimulate the national economy when
conventional monetary policy has become
ineffective.
– When short-term interest rates are either at, or
close to, zero, normal monetary policy can no
longer lower interest rates.
– Quantitative easing maybe used by the
monetary authorities to further stimulate the
economy by purchasing assets of longer
maturity than only short-term government
bonds, and thereby raising price but lowering
interest rates of the long term securities.
What is Quantitative Easing? Cont.
• How to implement QE?
– 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.
• With excess reserves, banks can make more loans.
– In comparison, conventional monetary policy is by
buying or selling government bonds to keep market
interest rates at target rate.
• Expansionary monetary policy involves the central
bank buying short-term government bonds
– lower short-term interest rates (via open market
operations).
Goal of QE
• 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
– leading to higher inflation,
– or of not being effective enough
• if banks do not lend out the additional
reserves.
Conventional Monetary Policy
• Conventional Monetary Policy
– A central bank conducts monetary policy 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 rates, the
federal fund rate
Why QE?
• 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.
Timeline
• 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 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.
Timeline cont.
• 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.
Effectiveness Of QE
• IMF
– QE contributed to the reduction in systemic risks
following the bankruptcy of Lehman Brothers.
– QE 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.
• 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 economic environment
of high unemployment and low inflation.
Effectiveness of QE (cont.)
• Increasing the money supply tends to depreciate
a country's exchange rates versus other
currencies.
– Exporters and debtors benefit from QE because of
cheaper $
– Importers and creditors are harmed from QE
• Banks might invest new money in
– emerging markets
– commodity-based economies
– non-local opportunities
– So local businesses still have difficulty getting loans.
Risk of QE
• Quantitative easing may cause higher inflation
than desired if the amount of easing required is
overestimated, and too much money is created.
• QE can fail if banks remain reluctant to lend
money to small business and households in order
to spur demand.
• In the context of a global economy, lower interest
rates may contribute to asset bubbles in other
economies.
– Cheap to borrow from US. The borrowed can be
invested in other countries. Bubble thus is created.
Printing Money or Not
• QE’s nickname: Printing money
• Difference
– QE: the newly created money is used for buying
government bonds or other financial assets
– printing money: newly minted money is used to
directly finance government deficits or pay off
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.
• They adopt two-step process
– government sells bonds to private entities which
the central bank then buys
Timeline
Timeline Cont.
Videos
• http://www.youtube.com/watch?v=PTUY16CkS-k
Quantitative Easing Explained
http://www.youtube.com/watch?v=oGIvw7T0GPI&feature=watch_response
Quantitative Easing Re-explained