Quantitative Easing – Are Markets Too Reliant on Unconventional Monetary Policy?
Some argue that Quantitative Easing (QE) practically saved the financial markets in the aftermath of the financial crisis in 2008. However, as problems increasingly arise, there is criticism that central banks, e.g. the US Federal Reserve and European Central Bank, are trapped with fuelling liquidity into markets, and are lost in their approach of expanding balance sheets and lowering rates.
The troubles of the US housing mortgage market, where subprime mortgages were handed out to individuals with poor credit scores and credit supply restricted to ordinary households and businesses, triggered a financial crisis in the USA. The following collapse of Lehman Brothers brought a great storm in the global financial system, and its effects were inevitably going to knock on the doors of the Bank of England. As a result, it was a huge task to recover the crippled economy. A series of major cuts in the interest rates from 5% down to 0.5% in October 2008 alone weren’t enough to stimulate borrowing and spending in the economy.
A new strategy would be needed to stimulate economic growth. Then-Chancellor Alistair Darling drafted the idea of Quantitative Easing (QE), which was first used in Japan in the early 2000s for their housing crisis. Essentially, QE is the central bank’s injection of money into the economy, using the newly printed digital money to purchase assets from the market, e.g. government debt, treasury bonds and assets backed by home loans. By buying financial assets, the central bank increases their price and therefore lowers their yield. This makes it easier for the government to borrow money going forward, with the interest rate offered on loans pushed down. QE has also played a role in strengthening stock markets, with investors buying shares from the new money they have effectively received from the central bank. In August 2016, the Bank of England announced the purchase of government bonds totalling £435 billion. Similarly, the US Federal Reserve also ran a QE programme, pumping $2 trillion into the money supply. While it added considerable debt to the Fed’s balance sheet from $2.106 trillion in November 2008 to $4.486 trillion in October 2014, the move has been credited with preventing the 2008 financial crisis from spiralling into the second Great Depression.
A decade from when it was initially proposed in both the UK and the USA, there is now debate is on whether QE has achieved its purpose. The argument in favour of QE is that it has practically saved the global economy from the prospects of complete collapse into another Great Depression. According to then-Chair of the Federal Reserve Ben Bernanke in 2012, the first two rounds of QE raised economic activity by almost 3%, and increased private-sector jobs by two million – a figure he believed would have been impossible without QE.
However, there remains strong criticism of QE. In Britain, QE has been criticised as contributing to wealth inequality. It is argued QE made people with assets richer, inflating asset bubbles in contrast to the less wealthy with mainly savings. According to the Financial Times, while those with lower incomes saw a bigger proportional rise in net wealth, wealthier households have seen much larger cash gains. Although researchers from the Bank of England have argued that the constant rise in house prices has meant that lower and middle-income households have seen a bigger proportional increase in their net worth compared to wealthier households, there is evidence indicating 10% of the least wealthy have only seen marginal increases in their measured real wealth by £3,000 between 2006-08 and 2012-14, compared to £350,000 for the wealthiest 10%.
There is also a strong fear amongst investors who believe the central bank is trapped in its interventions with liquidity. The federal reserve bank carries out expansions on the size of its balance sheet by buying securities, crediting banks with reserve and ultimately facilitating lending amongst banks. In the last two years. Both the European Central Bank and the US Federal Reserve have had a massive turnaround in their monetary policy. The US Federal Reserve went from raising interest rates four times in 2018 to cutting interest rates on three occasions in 2019, expanding its balance sheet by a great magnitude. Similarly, the European Central Bank had a “U-turn” in terms of its policy in 2018, ending its balance sheet expansion and steering away from further stimulus. The European Central Bank has now pushed its interest rate structure further into negative territory & re-stated its asset purchase programme. Some financial experts thus argue that the sudden change in monetary policy of both central banks implies they have given in to the pressure from the financial markets. On a monthly basis, the federal reserve bank prints $60 billion a month. There is worry that a stop in the middle of the financial year may be seen by the market as the end of QE, again leading to a tightening of financial conditions. The break in intervention from the central bank practically means physically taking liquidity out, raising questions over whether cutting interest rates further would be the Fed’s most appropriate reaction to falls in equity. Just recently, the Fed has cut interest rates again in response to the economic troubles brought by the coronavirus scare.
This leads to my conclusion that if anything, central banks around the world are trapped in the pressure of the financial markets. They will always be the institution pouring in liquidity in one way and another to support the market, and this may not be the end of cuts in interest rates.
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