Quantitative easing (QE) is an
unconventional monetary policy used by
central banks to stimulate the national economy when conventional
monetary policy has become ineffective.[1][2]
A central bank implements quantitative easing by buying
financial assets from
commercial
banks and other private institutions with
newly created money in order to inject a pre-determined quantity
of money into the economy. This is distinguished from the more usual
policy of buying or selling
government bonds to keep market interest rates at a specified target
value.[3][4][5][6]
Quantitative easing increases the
excess reserves of the banks, and raises the prices of the financial
assets bought, which lowers their
yield.[7]
Expansionary monetary policy typically involves the central bank
buying short-term government bonds in order to lower short-term market
interest rates.[8][9][10][11]
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.[12][13]
Quantitative easing can be used to help ensure inflation does not
fall below target.[6]
Risks include the policy being more effective than intended in acting
against
deflation – leading to higher inflation,[14]
or of not being effective enough if banks do not
lend out
the additional reserves.[15]
Process
Ordinarily, 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.[9][11]
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.[16][17]
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,[18]
can occur, for example, during
deflation or when inflation is very low.[19]
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.[5][20]
The goal of this policy is to increase the
money supply rather than to decrease the interest rate, which cannot
be decreased further.[21]
This is often considered a "last resort" to stimulate the economy.[22][23]
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.[24]
History
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 Japan has claimed that the central bank adopted a policy
with this name on 19 March 2001.[25]
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.[26]
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.[27]
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 19 March 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.[28]
Quantitative easing was used unsuccessfully by the Bank of Japan
(BOJ) to fight domestic
deflation in the
early 2000s.[12][29][30][31]
The Bank of Japan has maintained short-term
interest rates at close to zero since 1999. With quantitative
easing, it flooded commercial banks with excess
liquidity to promote private lending, leaving them with large stocks
of
excess reserves, and therefore little risk of a liquidity shortage.[32]
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.[33]
After 2007
More recently, similar policies have been used by the United States,
the United Kingdom and the
Eurozone during the
Financial crisis of 2007–2012. Quantitative easing was used by these
countries as their risk-free short-term nominal interest rates
are either at, or close to, zero. In the US, this interest rate is the
federal funds rate. In the 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.[34][35][36]
The
European Central Bank has used 12-month and 36-month
long term refinancing operations (LTRO) (forms of quantitative
easing without referring to them as such[37])
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".[38]
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.[21]
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.[citation
needed] These have the effect of depressing
interest yields on government bonds and similar investments, making it
cheaper for business to raise capital.[39]
Another side effect is that investors will switch to other investments,
such as shares, boosting their price and thus encouraging consumption.[21]
QE can reduce interbank overnight interest rates, and thereby encourage
banks to loan money to higher interest-paying and financially weaker
bodies.
Nevin argued that QE failed to stimulate recovery in the UK and
instead prolonged the recession between 2009 and 2012 as it caused a
collapse in the velocity of circulation, or rate at which money
circulates around the economy. This happened because QE drove down gilt
yields and annuity rates and forced pensioners, savers and companies to
hoard cash to counter the negative impact of QE on their investment
income.[40]
In 2012 the
Bank of England itself reckoned that quantitative easing had
benefited households differently, according to the assets they hold;
richer households have more assets.[41]
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).[42]
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.[43][44]
A third round of quantitative easing, or "QE3," was announced by the
Federal Reserve in September 2012. The third round includes a plan to
purchase US$40 billion of
mortgage-backed securities (MBS) per month. Additionally, the
Federal Open Market Committee (FOMC) announced that it would likely
maintain the
federal funds rate near zero "at least through 2015."[45]
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.[46]
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.[47]
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%.[48]
In October 2011, the Bank of England announced it would undertake
another round of QE, creating an additional £75 billion,[49]
in February 2012 it announced an additional £50 billion,[50]
in July 2012 it announce another £50 billion[51]
bringing the total amount to £375 billion. The Bank of England has said
that it will not buy more than 70% of any issue of government debt.[52]
This means that at least 30% of each issue of government debt will have
to be bought by other institutions.
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.
[53]
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.[54]
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).[55][56]
In October 2011 the Bank of Japan expanded its asset purchase program by
¥5 trillion ($66bn) to a total of ¥55 trillion.[57]
QE1, QE2, and
QE3
The expression "QE2" became a "ubiquitous
nickname" in 2010, when used to refer to a second round of quantitative
easing by central banks in the United States.[58]
Retrospectively, the round of quantitative easing preceding QE2 may be
called "QE1". Similarly, "QE3" refers to the third round of quantitative
easing following QE2.[59][60]
QE3 was announced on 13 September 2012. In an 11-to-1 vote, the
Federal Reserve decided to launch a new $40 billion a month, open-ended,
bond purchasing program of agency
mortgage-backed securities and also to continue extremely low rates
policy until at least mid-2015.[61]
According to NASDAQ.com, this is effectively a stimulus program which
allows the Federal Reserve to relieve $40 billion dollars per month of
commercial housing market debt risk with no maximum amount or time
limit.[62]
Ratings firm Egan-Jones said it believes the Fed’s decision “will hurt
the U.S. economy and, by extension, credit quality.” As a result the
firm once again slashed the U.S. bond rating bringing it down to AA-.
Federal Reserve chairman Ben Bernanke acknowledged concerns about
inflation.[63]
Effectiveness
According to the
IMF, 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.[64]
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.[65]
Former
Federal Reserve Chairman
Alan Greenspan calculated that as of July 2012 there was "very
little impact on the economy" and noted "I'm very surprised at the
data."[66]
Federal Reserve Governor Jeremy Stein has said that measures of
quantitive easing such as large-scale asset purchases "have played a
significant role in supporting economic activity."[67]
Risks
Adverse impact on savings and pensions
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.[68]
Lowering interest rates can actually hurt the economy if
people who depend on interest income spend less in response to their
reduced income. In general, however, the Federal Reserve has assumed
that the advantages of the low interest rates outweigh this effect,
though they often admit that seniors may be hit as
collateral damage.[citation
needed]
In the
European Union,
World Pensions Council (WPC)
financial economists have also argued that QE-induced artificially
low
interest rates will have an adverse impact on the underfunding
condition of pension funds as “without returns that outstrip inflation,
pension investors face the real value of their savings declining rather
than ratcheting up over the next few years”[69]
Inflation from purchasing liquid assets
Quantitative easing may cause higher inflation than desired if the
amount of easing required is overestimated, and too much money is
created by the purchase of liquid assets.[14]
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.
It should be noted that
mortagage-backed securities such as are being purchased as part of
the QE3 program are not based on liquid assets, and their purchase does
not entail inflation risks. If the easing resulted in an expansion of
the money supply, it would be expected to cause an inflationary effect
(as indicated by an increase in the annual rate of inflation). Since
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.[70]
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. Increasing the money
supply tends to depreciate a country's
exchange rates versus other currencies. This feature of QE directly
benefits exporters residing in the country performing QE and also
debtors
whose debts are denominated in that currency, for as the currency
devalues so does the debt. However, it directly harms
creditors 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.[71]
Housing market over-supply and QE3
The only member of the
Federal Open Market Committee to vote against QE3, Richmond Federal
Reserve Bank President
Jeffrey M. Lacker, said:
"The impetus ... is to aid the housing market. That's an area
that's fallen short in this recovery. In most other U.S. postwar
recoveries, we've seen a pretty sharp snap back in housing. Of
course, the reason it hasn't come back in this recovery is that
this recession was essentially caused by us building too many
houses prior to the recession. We still have a huge overhang of
houses that haven't been sold that are vacant. And it's going to
take us a while before we want the houses we have, much less
need to build more."
[72]
Capital flight
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.[73]
Comparison with other instruments
Qualitative easing
Professor
Willem Buiter, 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:
Quantitative easing is an increase in the size of the balance
sheet of the central bank through an increase [in its] monetary
liabilities (
base
money), holding constant the composition of its assets.
Asset composition can be defined as the proportional shares of
the different financial instruments held by the central bank in
the total value of its assets. An almost equivalent definition
would be that quantitative easing is an increase in the size of
the balance sheet of the central bank through an increase in its
monetary liabilities that holds constant the (average) liquidity
and riskiness of its asset portfolio. Qualitative easing is a
shift in the composition of the assets of the central bank
towards less liquid and riskier assets, holding constant the
size of the balance sheet (and the official policy rate and the
rest of the list of usual suspects). The less liquid and more
risky assets can be private securities as well as sovereign or
sovereign-guaranteed instruments. All forms of risk, including
credit risk (default risk) are included.
[74]
Credit easing
In introducing
the Federal Reserve's response to the 2008–9 financial crisis, Fed
Chairman
Ben Bernanke distinguished the new programme, which he termed "credit
easing" from Japanese-style quantitative easing. In his speech, he
announced:
Our approach—which could be described as "credit
easing"—resembles quantitative easing in one respect: It
involves an expansion of the central bank's balance sheet.
However, in a pure QE regime, the focus of policy is the
quantity of bank reserves, which are liabilities of the central
bank; the composition of loans and securities on the asset side
of the central bank's balance sheet is incidental. Indeed,
although the Bank of Japan's policy approach during the QE
period was quite multifaceted, the overall stance of its policy
was gauged primarily in terms of its target for bank reserves.
In contrast, the Federal Reserve's credit easing approach
focuses on the mix of loans and securities that it holds and on
how this composition of assets affects credit conditions for
households and businesses.
[75]
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.[76][77]
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.[76][77]
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.[78]
Printing money
Quantitative easing has been nicknamed "printing money" by some
members of the media,[79][80][81]
central bankers,[82]
and financial analysts.[83][84]
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).[79]
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.[78][85]
This two-step process, where the government sells bonds to private
entities which the central bank then buys, has been called "monetizing
the debt" by many analysts.[78]
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).[79]
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.[78]
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).[86][87]
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".[88][89]
Richard W. Fisher, president of the
Federal Reserve Bank of Dallas, warned that a potential risk of QE
is, "the risk of being perceived as embarking on the slippery slope of
debt monetization. We know that once a central bank is perceived as
targeting government debt yields at a time of persistent budget
deficits, concern about debt monetization quickly arises." and later in
the same speech states that the Fed is monetizing the government debt,
"The math of this new exercise is readily transparent: The Federal
Reserve will buy $110 billion a month in Treasuries, an amount that,
annualized, represents the projected deficit of the federal government
for next year. For the next eight months, the nation’s central bank will
be monetizing the federal debt."[90]
Altering debt maturity structure
Based on research reassessing the effectiveness of the US
Federal Open Market Committee action in 1961 known as
Operation Twist,
The Economist, based on research by economist Eric Swanson, has
posited that a similar restructuring of the supply of different types of
debt would have an effect equal to that of QE.[91]
Such action would allow finance ministries (e.g., the
US Department of the Treasury) a role in the process now reserved
for central banks.[91]