The Technique of Quantitative Easing - Essay Example

Through Quantitative Easing (QE), central banks buy long-term government bonds with newly printed money. This raises the bonds prices, lowers their yields and provides a helpful boost to growth when central banks main tool, the short-term interest rate, is close to zero. But there are plenty of disputes over whether QE works.” - Discuss by collecting and analyzing historical data and by giving up-to-date real life example(s) from the Japanese, American, UK or EU economies with actual figures. Contents Contents 2 Introduction 3 Discussion 3 Quantitative easing: background 3 Research question and objectives 4 Interpretation of the research question 5 Purpose and procedure of study 6 Empirical evidence 7 Analysis and debate 9 Conclusion and recommendations 11 References 13 Introduction The study on the technique of quantitative easing has been carried out as per the outline given below. At first, the theoretical background of quantitative easing has been studied in order to understand the merits and demerits of the techniques. The research question has been framed and the objectives of the research are outlined. The research question is interpreted and the purpose of conducting the research is determined. The research has been carried out in the context of the economies of US, UK, Japan and the European Union. The procedure of the study is then fixed based on which the work has been carried out. The empirical evidence of quantitative easing in then discussed in the context of the economy of US, UK, European Union and Japan. The empirical evidence and the role of the central banks in stimulating the economic growth, stemming deflation and controlling inflation have been analyzed in this work. Based on the research findings and conclusion, the recommendations for future in the field of quantitative easing have been given. The recommendations include the several conditions under which the quantitative easing should be employed by the central banks in future. The lessons learnt should also be used by the central banks in undertaking quantitative easing approach in phases in order to prevent the adverse effects of inflation on the economy. Discussion Quantitative easing: background The economic policy of quantitative easing is adopted by the central banks in many economies as an alternate to the conventional monetary policy which is a tool for stimulating the economy. The quantitative easing strategy is applied when the monetary policy has no further effects on the economy. The monetary policy is aimed at controlling the liquidity in the economy by the varying the short term interest rates. The governments also adopt the expansionary monetary policy under the circumstances of liquidity crunch in the economy which involves purchase of short term government bonds and lowering the yield of these bonds. Even after such measures, there are economic scenarios faced by the central banks when the short term interest rates have reached close to zero. Under such circumstances, the central banks adopt the strategy of purchasing the government bonds which are of long term maturity rather than the short term maturity bonds. By lowering the yields of these long terms bonds, the government aims to improve the liquidity in the economy over the long term period. However, the strategy of quantitative easing could have adverse effects on the inappropriate lending policy of commercial banks, etc. Therefore, it could be understood from this background study that the quantitative easing technique has both advantages as well as disadvantages and the role of the central banks in crucial in balanced implementation of the technique. From this point of view, the study on the quantitative easing techniques applied by the central banks in the economies of US, UK, EU and Japan is important. Research question and objectives The research question that has been addressed in this work is, “Study the rationale behind adoption of quantitative easing technique by the central banks in various economies of the world. Analyze the impacts of quantitative easing on the economic performance of the country.” The research question has the objectives of explaining the importance of quantitative easing technique of the central banks in influencing the economic performance of the country. The various conditions to be fulfilled for application of the quantitative easing approach would be examined with the help of this research. The role of the central banks in the economies across the world in applying the quantitative easing technique would be reviewed with the evaluation of the results of quantitative easing. The work aims to research on the economic conditions that leads the government to undertake techniques of quantitative easing. The theoretical knowledge of quantitative easing would be applied in context to various economies like US, UK, EU and Japan to determine the implications of quantitative easing. Considering the merits and the demerits of quantitative easing, it would be analyzed whether the central banks have been able to fulfil their goals of stimulating the economic growth and the control actions taken by them to remove the adverse effects of the technique of quantitative easing. Interpretation of the research question The research question has been interpreted on the background of the theoretical framework of quantitative easing technique which has been adopted by the central banks as an economic tool to stimulate the growth and development of the economy. The research on the economic conditions, in which quantitative easing is adopted by the central banks, provides us with the limitations of the expansionary monetary policy. The fluctuation of the short terms interest rate are not possible once the rates are very close to zero. This brings into the picture the concept of quantitative easing in which the central banks purchase the government bonds of long term maturity. The research question has been able to reveal the role played by the central banks in injecting liquidity in the economy and stimulating the economic demand. The interpretation of the research question also takes into consideration the control measures adopted by the central banks in order to prevent the economy from the problems of excess liquidity or inappropriate lending policies of the commercial banks. The development of the economy could be understood from the analysis of the stock market index for the period in which the quantitative easing is applied. Purpose and procedure of study The purpose of this study is to validate the theoretical background of quantitative easing through the analysis of the application of this techniques by the central banks in various economies like the US, UK, EU and Japan. The study has been undertaken through collection of data and information on the policies of the central banks in the economies of US, UK, European Union and Japan. The various economic conditions in these countries under which the central banks have adopted this policy have been studied in this work. The collection of data has been done mainly from the secondary sources like online referrals, academic books, journals, etc. These data contain reliable insights on the economic scenario of US, UK, Japan and European Union economies. The impacts of quantitative easing on the economic performance of the countries have been understood from the performance of the stock indices in those economies. The control measures adopted by the central banks to prevent high inflations rates and economic imbalance have been studied. The findings have been used to validate the background study and empirical evidence in the context of the economies like US, UK, EU and Japan. Empirical evidence The empirical evidence on quantitative easing could be observed from the review of literature in context to the economies of US, UK, EU and Japan. Considering the US economy, the first round of quantitative easing started after the global financial crisis when there was a liquidity crunch in the economy and the short term interests rates reached close to zero through the application of expansionary monetary policy (Christensen and Rudebusch, 2012, p.75). The government then adopted the first round of quantitative easing in 2008 which lasted till 2010. During this period, the stocks of the companies were sold in large numbers which finally dipped at the end of quantitative easing tenure in 2010. The second round of quantitative easing started in 2010 which boosted the S&P 500 and then dipped again at the end of tenure in 2011. After the operation twist, the third round of quantitative was started by the US Federal Reserve in mid-2012 and then again expanded in end of the same year. In 2012, the Fed purchased $40 billion mortgage backed securities per month. The chart given above depicts that each time; the US Federal Reserve was able to stimulate the economy through quantitative easing which is reflected in the increasing sale of stocks of S&P 500 (Yahoo Finance, 2014, p.1). In the context of UK’s economy, it could be found that the quantitative easing has been adopted by the central bank of UK, i.e. The Bank of England after the fall of the Lehmann Brothers and the slowdown of the financial markets due to the liquidity crunch. The quantitative easing technique was adopted at a point when the interest rates fixed by the Bank of England reached its lowest values. The Bank of England undertook the policy of purchasing 375 billion pounds of governments bonds with an aim to stimulate the economy through injection of liquidity (O’Connor, 2014, p.1). The late news published by the bank of England suggests that they intend to hold the interest rate which is at a record low of 0.5% and also to maintain the treasury stock which purchases of government bonds worth 375 billion pounds. Japan’s economy is the fourth biggest economy in the world and has been undergoing a market deflation over the last decade and a half. While the Federal bank has been looking to taper its approach of quantitative easing, the Bank of Japan has embarked freshly into quantitative easing with the recent decision on the purchase of government bonds amounting to 7 trillion Yen (Fasano-Filho and Wang, 2002, p.48). A similar situation has been faced by the European Central Bank due to the fall of the inflation rate to 0.7% in the recent past. The probable occurrence of deflation is looming large over the economies of European Union. In order to counter the impacts of probable impacts of deflation, the European Central Bank has reduced the interest rate to the lowest figure of 0.25%. In order to stimulate the economies of the European Union, the European central Bank has proposed to adopt the policy of quantitative easing in order to pump more liquidity in the economy. Analysis and debate The quantitative easing technique was adopted by the US Federal Reserve after the global financial crisis when the monetary policy of the government started to become ineffective as the reduction of the short term interest rates close to zero were still not able to address the liquidity crunch in the economy. The Fed, therefore, adopted the strategy of purchasing the long term government bonds in order to inject liquidity in the economy. The shortage of the government bonds in the market in meeting the demands of the investors led to the rise in the prices of the bonds and reduction of yield. The investors shifted into investment in stocks with the help of liquidity injected by Fed in the US market. This has been reflected in the rising performance of S&P 500 during the period of quantitative easing during 2008 to 2013. However, the Federal bank has also maintained a balance between the economic growth and the possibilities of inflation through control over the quantitative easing approach. The tenure of the government bonds have selected appropriately by the Fed. The Federal bank kept a close eye of not allowing excess liquidity in the economy that would lead to excess demand over supply and subsequent higher inflation rates. For this reason, the quantitative easing technique has been divided into several time gaps over which the economic status has been reviewed and revised approach of quantitative easing has been adopted in the last five years. The Federal Reserve has also started to taper the purchase of government bonds worth $85 billion dollars month at present to $75 billion dollar per month. The economy of UK has been recovering fast since the adoption of the quantitative easing technique by the Bank of England. The policy of quantitative easing is justified as the central bank in UK had faced a situation in which the short term interest rates reached a lowest figure of 0.5% and the monetary policy could not be applied for stimulating the economy. The rising prices and the reduction of government bond yield resulted into preference of investment in the stocks. The investment in FTSE stocks increased in large numbers and that boosted the economic performance of UK as indicated in the chart given below (The Financial Times Ltd, 2014, p.1). However, the debate over holding the interest rates and the quantitative easing could be argued as a measure of maintaining balance between the economic growth and inflation and unemployment. The Bank of England has expressed their intentions of not raising the interest rates until the unemployment rate reduce to 7%. The quantitative easing technique adopted by the Japan’s central bank was aimed at injecting liquidity in the economy in order to counter the scenario of deflation that hampered the growth of production and services in the economy. The purchase of the government bonds by the Japan’s central bank have been effective in injecting liquidity in the economy for which the demand of the economy has increased and the deflation rate has been stemmed. The currency of Japan depreciated which lifted the domestic economy and the inflation rate touched 1.6% in 2012. The interest rates have been fixed at a historically lower rate of 0.25% by the European central Bank. Thus the strategy of quantitative easing is the only option left for the central in order to inject liquidity in the economy. The injection of liquidity in the economy has played the role of stimulating the demand against the prevailing level of supply (Bilbao-Ubillos, 2013, p.57). This has given rise to the hike in the prices of goods and services and thus would be able to control the aspect of deflation in the economies of European Union. Conclusion and recommendations From the above study on the background of quantitative easing and the application of these techniques by the central banks in the US, UK, European Union and Japan, it could be observed that the quantitative easing of government bonds and financial assets is an economic tool that has been adopted by the Federal Reserve, Bank of England, European Central Bank and the Bank of Japan at a time when the monetary policy has become ineffective in stimulating the economy of the respective countries and the short term interest rates reached a historic low value. By integrating the theoretical background with the empirical evidence, it could be recommended that in future the central banks should undertake the policy of quantitative easing only when the short term interest rates are at an all time low and there is a need to inject liquidity into the economy for stimulating the economic growth. The quantitative easing leads to preferred option of investment in stocks as the prices of the bonds become higher and the yields are lowered. This has boosted the economies of US and UK and the unemployment rates started to decline. The quantitative easing could also be applied by the central banks in order to control deflation in future as it happened in the economies of EU and Japan. However, the central banks should also note the adverse effects of excess liquidity in the economies due to quantitative easing that result into inflation. The central banks should also monitor the lending activities of the commercial banks in order to percolate the injected liquidity in the hands of the people. References O’Connor, S. 2014. Bank of England holds interest rates and quantitative easing. [Online]. Available at: http://www.ft.com/intl/cms/s/0/51c753a6-5d00-11e3-81bd-00144feabdc0.html#axzz2tqYx5mI6. [Accessed on 20 February, 2014]. The Financial Times Ltd. 2014. FTSE 100 Index. [Online]. Available at: http://markets.ft.com/research/Markets/Tearsheets/Summary?s=FTSE:FSI. [Accessed on 20 February, 2014]. Yahoo Finance. 2014. S&P 500. [Online]. Available at: http://finance.yahoo.com/echarts?s=%5Egspc+interactive#symbol=%5Egspc;range=5y;compare=;indicator=volume;charttype=area;crosshair=on;ohlcvalues=0;logscale=off;source=;. [Accessed on 20 February, 2014]. Bilbao-Ubillos, J. 2013. The Economic Crisis and Governance in the European Union: A Critical Assessment. New York: Routledge. Fasano-Filho, U. and Wang, Q. 2002. Bank of Japans Quantitative and Credit Easing: Are They Now More Effective. Washington D.C: International Monetary Fund. Christensen, J. and Rudebusch, G. 2012. The Response of Interest Rates to US and UK Quantitative Easing. The Economic Journal. 122(564), pp. 385-414. Read More