Evaluation of Three Quantitative Easing Periods in Asia - Term Paper Example

Effects of U.S. Quantitative Easing on Emerging Asia: Evaluation of Three QE Periods from 2009 to 2013 Quantitative easing, however unorthodoxed it might seem before when it was first applied in Japan, has become a number of central banks’ emerging strategy for pumping cash into an economy to lower long-term interest rates and to boost the economy, during instances when interest rates have reached almost zero rates. Though increasing implemented across the world, QE or quantitative easing remains an unconventional monetary policy because of its potential positive and negative effects on the economies of interconnected developed and developing economies. The paper discusses the effects of U.S. quantitative easing on the Asian economy, which is vulnerable to economic changes in the U.S. due to interconnected global markets. The comparison is done for three QE periods, where an assessment was made from comparing baseline data in November 2009 to October 2010 to three QE periods in 2009 to 2013. It also explores the recent effects of QE and impacts of QE tapering on Asia. It will be helpful to discuss the historical perspective of QE in the world to understand its nature and purposes. Interest rates in industrial countries have dropped to almost zero after the 2008 global crisis because of monetary policies that sought to turnaround the economy, which limits the ability of federal banks to use additional monetary easing that could further lower interest rates policy (Morgan 3; Joyce, Miles, Scott, and Vayanos F272). QE and other asset purchase programs are the next resort of central banks during extraordinary circumstances that the interest rates were pushed down further. Japan is noted as the first country that applied QE in 2001 (Ncube). After the 2008 financial crisis, Central Banks of other developed countries began using QE regularly to fuel their economies, boost bank lending, and promote spending (Ncube). In the U.S., QE refers to Federal programs of direct purchases of US Treasury notes and bonds (Morgan 3)/ The Fed does not actually call it QE, but rather it is officially termed as “Large-scale Asset Purchases” (LSAP) program, which is composed of agency securities and mortgage-backed securities (Morgan 3). QE is also called “credit easing” (Morgan 3). The fundamental goal of QE is to promote economic growth through lowering long-term interest rates. The U.S. and affected Asian economies are worried of QE because of the negative impacts of U.S. QE on their economies. Some of which are the following: (1) QE weakens USD (Fratzscher, Duca, Marco, and Straub 2); (2) Rising expectations of future currency appreciation stimulates capital outflows to emerging Asian economies (Fratzscher, Duca, Marco, and Straub 2); and (3) Increases inflationary pressures on Asian countries (Morgan 3). These predicted and perceived effects were not baseless, as shown in the evaluation of QE effects on emerging nations. The approach of the analysis is to take the period of November 2009–October 2010, when no QE happened, as a baseline period (“No QE”), and compare it with effects of quantitative easing on monetary flows during the QE1 and QE2 periods (Morgan 3). The base period is chosen for stability of Fed’s balance sheet (Morgan 3). QE1 pertains to Fed purchases of $300 billion, from 18 March 2009 (announcement) to October 2009. QE2 includes purchases of Fed purchases of 600 billion of Treasuries, from 3 November 2010 (announcement) to June 2011 (Morgan 3). QE3 refers to this policy “intended to lower borrowing costs and ease credit conditions for the private sector to promote growth and employment as the crisis subsided” (Cho and Rhee 3). The Fed’s total asset had reached $3 trillion as of January 2013” (Cho and Rhee 3). Window analysis is chosen because market factors, such as exchange rates and interest rates, are anticipated to change due to announcements of policy changes, the report relied on event window analysis. After discussing the history and purposes of QE in the U.S., the next exploration is for the changes first in U.S. securities and monetary base during QE. For QE 1, the Fed bought a total of $1.1 trillion holdings. See Table 1. It shows that the Fed purchased 316% more than it did when there was no QE (Morgan 5). For QE2, the Fed decreased its purchases from $1.1 trillion to $593 billion. Total outright holdings is lower than the purchases of US treasuries that reached $773 billion, which means that the U.S. saw a decline in asset-backed securities (Morgan 5). Table 1: Changes in Federal Reserve Outright Holdings of Securities and U.S. Monetary Base Source: Morgan 5 Figure 1 provides the equivalent increases of the U.S. monetary base, which is the means of liquidity for the economy. In QE1, base money increased by $374 billion almost fully because of the increase in reserves that the Fed had. Morgan asserted that the net impact on liquidity should be evaluated in context of all of the Fed’s activities, not just Treasury purchases (5). Figure 1: Components of the U.S. Monetary Base Source: Morgan 5 For QE2, base money increased by $687 billion, twice more than the rise in Fed’s Treasury holdings and less than twice the increase in QE1 (Morgan 5). It suggests that in QE2, the Fed decreased programs for short-term and outright assets, so the trends in total assets followed the same as the outright holdings of Treasuries (Morgan 5). The most direct transmission of the quantitative easing impact to Asia is via increased capital flows (Morgan 6). After the large repatriation flows at the apex of the global financial crisis in three quarters from April through December 2008, US gross capital outflows continued from January to March 2010, lasting until January to March 2011 (Morgan 6). On the contrary, the net repatriation of $23 billion in April to June 2011 came from a massive reverse inflow of other investments worth $196 billion (Morgan 6). Majority of this inflow, $186 billion, came from “Other Western Hemisphere,” such as offshore centers in Cayman Islands (Morgan 6). The reversal suggested concerns over the Eurozone crisis and a decelerating growth of the U.S. (Morgan 6). This outcome reduced the ability of the QE2 policy to promote capital outflows (Morgan 6). Table 2 offers a summary of the total private capital outflows. These figures are adjusted to quarterly average rates to provide for the different durations of concerned periods (Morgan 7). Table 2 indicates that outflows were higher in QE1 than interim period, where the difference or “excess” compared to the baseline period is significant particularly for portfolio flows. Direct investment also fell in QE1, because it is expected that direct investment is not sensitive to QE policy since it has a long-term dimension (Morgan 7). Table 2: U.S. Gross Private Capital Outflows Source: Morgan 6 Column 6 demonstrates the existence of a negative excess during QE2 of around $27 billion per quarter, primarily because of significant negative excess of $52 billion for private claims (Morgan 7). This may be a product of a large shift in market attitudes that began around April to June 2011 because of deplorable global economic conditions, particularly in Europe, that exacerbated the effects of QE2 policy (Morgan 7). The figures for the first two quarters of QE2 show excesses relative to the baseline. They indicate a large excess of outflow of $73 billion per quarter, more than twice in QE1. Majority of these outflows, around $60 billion, arose from private claims, while the excess of portfolio outflows was largely less than during QE1. The gap in the size of the total outflows is consistent with the relative sizes of Treasury purchases and increases in base money for QE1 and QE2, although the composition of these outflows different between QE1 and QE2 (Morgan 7). The bottom part of Table 2 indicates the average quarterly increase in the monetary base throughout these periods and the share of the excess capital outflow of the increase (Morgan 7). In QE1, 41% of the increase in the monetary base may have leaked to other nations, while the ration for the first two quarters of QE2 is lower at 34%, which is still seen as noteworthy (Morgan 7). We should consider that these estimates are approximates because it is hard to detach QE effects from heightened economic optimism that can lead to greater capital outflows too (Morgan 7). Table 3 shows the development of private financial inflows to Asia during the QE periods. It is surprising that for the whole of Asia Pacific, there was an absence of excess outflows during QE1 and QE2. These results would remain even if direct investment was removed (Morgan 9). Table 3: Gross Private Capital Outflows from U.S. to Total and Asia Pacific Source: Morgan 9 Even if there were excess outflows on the side of portfolio, specifically in QE2, these were offset by bigger repatriation of other private claims, specially through loans (Morgan 9). The effects for Emerging Asia are similar, no excess outflows for both QE1 and QE2. Similarly, excess outflows on the portfolio account were more than counterbalanced by repatriation of other private claims (Morgan 9). Table 3 shows the development of private financial inflows to Asia during the QE periods. It is surprising that for the whole of Asia Pacific, there was an absence of excess outflows during QE1 and QE2. These results would remain even if direct investment was removed (Morgan 9). Even if there were excess outflows on the side of portfolio, specifically in QE2, these were offset by bigger repatriation of other private claims, specially through loans (Morgan 9). The effects for Emerging Asia are similar, no excess outflows for both QE1 and QE2. Similarly, excess outflows on the portfolio account were more than counterbalanced by repatriation of other private claims (Morgan 9). Table 4 shows similar trends for the data of major Asian economies. Only the PRC and Hong Kong, China demonstrated large excess outflows from the U.S, and this is only throughout the QE2 period (Morgan 9). The excess outflows for Hong Kong, China was a product of large excess portfolio flows (Morgan 9). Korea had excess portfolio outflows for QE1 and QE2, but private claims also offset these outflows (Morgan 9). Singapore showed unexpected figures because they exhibited repatriation on the portfolio for all three periods (Morgan 9). Figure 2: Net capital flows to emerging markets, 1990–2013 Source: Subramanian 5 Figure 2 shows net capital inflows to emerging nations from 1990 to 2013. Net capital inflows show declines in capital flows in emerging countries in Asia (Subramanian 5). The early part of the QE era (QE1 and QE2) showed large net flows of capital to EMs (composed as share of EMs’ GDP). But flows have dropped since QE1 with some continuation after the threatened withdrawal of QE in May 2013 (Subramanian 5). Figure 3: Capital Outflows in Asia Source: Choo and Rhee 8 Figure 3 shows the composition of capital outflows for all Asian countries except Hong Kong, China and Singapore. It shows that other investments were more volatile than portfolio investment around the period of global financial crisis (GFC) than US QE, suggesting that Asian residents were not as exposed to external capital markets as foreign investors were to Asian markets (Cho and Rhee 8). As for the question on the direction of outflows, based on Table 5, the money went to Europe (Morgan 10). It shows that excess outflows to Europe for QE1 and QE2 were much larger than total excess outflows (Morgan 10). Excess flows in QE1 to Europe were around four times higher than global excess flows (Morgan 10). Large excess flows were evident in the portfolio and other private claims accounts. Table 5: Gross Private Capital Outflows from U.S. to Total and Europe Source: Morgan 11 In Europe, the United Kingdom (UK) received two-thirds of Europe’s excess outflows during QE1 and a third during QE2, an uneven share considering its size (Morgan 10). This hints that financial markets in Europe, specifically London, served as vehicle for flows to the rest of the world, so it is wrong to see direct bilateral flows between the U.S. and destination countries to evaluate the impacts of the QE policies (Morgan 10). The next concern is to identify the effect of these inflows on domestic liquidity conditions in Emerging Asia (Morgan 15). The first phase for these capital flows to go into Emerging Asian economies is an increase in foreign exchange reserves (Morgan 15). - In April to September 2009, the total foreign exchange reserves for Emerging Asia economies increased by $258 billion per quarter (Morgan 15). - This is higher than the increase in the past three months of only $15 billion (Morgan 15). More than 60% of the increase happened in the PRC, after the increases of 9% in Korea and 8% in Hong Kong, China (Morgan 15). - The excess increase in QE1 compared to the base period was fairly big at $89 billion per quarter (Morgan 15). It is hard then to link QE1 policy and inflow effects because there are no excess capital inflows into Emerging Asia during this period (Morgan 15). For the first two quarters of QE2, total foreign exchange reserves of these economies increased by around $185 billion per quarter (Morgan 15). In this case, the estimated excess increase was $16 billion, close to the estimate of the excess total private financial inflow of around $9 billion (Morgan 15). Excess amount is somewhat small compared to the overall increase of foreign exchange reserves during the period (Morgan 15). Table 6 also shows the total increase in the monetary base in U.S. dollars in Emerging Asia in the QE periods (Morgan 16). It can be seen that there is no excess increase during QE1, which is consistent with the finding of no excess increase in capital inflows although not with the rise in revenues (Morgan 16). During the QE2 period, there is an excess increase in monetary base of $19 billion per quarter, which is close to the excess increase of foreign exchange reserved throughout the period (Morgan 16). This means that the increase in forex reserves was not sterilized (Morgan 16). It would have been fairly easy for the monetary authorities to sterilize the amount given that it is $16 billion per quarter or 1.2% of the total monetary base (Morgan 16). The direct effect of the QE policies on domestic liquidity in Emerging Asia seems to be modest and easily controlled through the sterilization policy (Morgan 16). There are other transmission mechanisms of QE on Emerging Asian economies, including interest rates and currencies (Morgan 16). Some studies found out that because of LSAPs, US Treasury bond yields fellow down, and that US dollar fell by 3.6% to almost 10.8%, depending on the currency used (Morgan 16). The effect was significant during the LSAP purchase announcement dates (Morgan 16). Using the 2-day event window for these announcement days: Korean won increased by 10 percentage points. Singapore dollar increased by 3.3 percentage points. Indian rupee increased by 2.1 percentage points. Other Asian currencies did not show significant responses. This shows a combination of effects of foreign exchange intervention and capital inflow restrictions (Morgan 16). After the two QE periods, currency value responses varied across emerging Asian countries, however, the study of Choo and Ree showed that economies with stable exchange rates generally correspond with those in which housing prices have been escalating, implying that monetary easing of advanced countries have shaped Asian countries through, first, appreciation of currency values (Choo and Ree 2). The second effect is that US QE has also led to increases in the prices of housing (Choo and Ree 2). Apart from higher house prices, ultra-low interest rates have significantly shaped other forms of capital flows to emerging markets, and specifically, foreign investor purchases of emerging-market bonds (McKinsey Global Institute 36). Cross-border lending has decreased since 2007, and there has been a rise in the purchase by foreign investors of bonds issued by emerging market governments and companies (See Figure 2). Some of these purchases have more than tripled from $80 billion in 2009 to $264 billion in 2012 (McKinsey 36). This phenomenon enabled these economies to conduct large international bond issuances (McKinsey 36). Bond yields have risen in 2013 forseveral economies in the Association of Southeast Asian Nations (ASEAN). See Figure 3. Indonesia experienced the biggest surge in bond yields, with the 10-year yield increase from less than 6.0% at the beginning of June to nearly 7.9% on 19 July (Ng 1). Singapore and the Philippines also witnessed 10-year yields rising, while yields for Malaysian and Thai bonds stayed somewhat stable (Ng 1). The disparity between the performances of Malaysian and Indonesian bonds is remarkable since both countries have a high level of foreign ownership in their local currency (LCY) government bond markets: 31.2% and 32.6%, correspondingly, as of end-March 2013 (Ng 2). Nevertheless, as Ng showed in his ADB paper: “Malaysian bonds seem to have avoided the sell-off so far, suggesting that foreign investors may not be selling indiscriminately. Instead, the selling may be restricted to markets perceived to be riskier” (2). The first part of the QE era (QE1 and QE2) showed large net flows of capital to EMs (as a share of EMs’ GDP). These flows fell since and more so before the threatened withdrawal of QE in May 2013 (Subramanian 4). The impact of QE on exchange rates on Indonesia, for instance, in 2013, is depreciation, which also happened for India, based on IMF data (Subramanian 4). Cho and Rhee studied the impacts of QE variables on Asia using regression on three main financial variables- CDS or Credit Default Swap premium on 5-year sovereign debt; BOND or local currency denominated bond yield rate on 5-year government bonds; and EXR or exchange rate against the U.S. dollar using eight Asian economies: The PRC, Hong Kong, Japan, Republic of Korea, Malaysia, the Philippines; Thailand; and Singapore. Looking at this table, it can be seen that QE 1 events had large effects on domestic financial variables, while QE2 and QE3 had little effects (Cho and Rhee 13). Though there are several exceptions, QE1 decreased CDS, BOND, and EXR through local currency appreciation (Cho and Rhee 13). The effect of some QE events were significant after controlling indirect effects through USRate (Cho and Rhee 13). It appears that only QE1 had large impact on Asian currency values. Also, when USRATE was lower, Asia’s BONDs were also lower. Cho and Rhee concluded that Qes decreased USRATE, thereby “easing financial conditions in Asia” (13). This table shows the tradeoff between exchange rates and housing prices. Except for Japan, the correlation coefficient for the two mentioned variables is -0.84 which suggested that QE affected Asia through housing price increases (Cho and Rhee 15). The end of QE starts when the central bank stops buying additional securities (Fabbri 4), and several studies already showed projections or estimations of its negative effects. Tightening begins when central bank sells securities, though there is an intermediate step (Fabbri 4). This is how the markets will look like when QE has ended: Long-term interest rates will go up, search for yield will decreases, credit spreads will expand, and bond exchange rates will fall relative to the Dollar and the Euro (Fabbri 4). Emerging nations are now tightening monetary policy in anticipation of tapered QE (Fabbri 4). As asset inflation grows, capital outflows may occur, as well as, slowing of economic growth (Fabbri 6). They can also experience higher rates and sharp hits on their balance sheets because of the flooding of foreign funding in emerging markets (Fabbri 6). Sharp currency adjustment is another effect of QE tapering (Subramanian 1). Cho and Ree’s estimations showed that emerging markets with the biggest appreciation of real exchange rates and the biggest increase in their current account deficits before QE experienced the sharpest currency depreciation, reserve losses and stock market declines when the Fed announced QE tapering. Cho and Ree also observed that countries with larger markets experienced greater pressure on the exchange rate, foreign reserves and equity prices, due to expectations of QE tapering. The impacts of the “taper talk” were not the same for all emerging markets. Acute pressures were perceived more in macroeconomically vulnerable economies, such as Indonesia and India. These countries “high current account deficits, rendering them vulnerable to reversals of foreign flows, and in many cases also faced a sharp deceleration in economic growth” (Subramanian 8). One report stated: “China and Singapore, which had healthy reserves and current account surpluses, saw their currencies appreciate” (Subramanian 9). QE1 resulted to high contributions to sharp rebound in capital inflows to Asia. QE1 reduced tail risks and lowered US yield rates, thereby redirecting capital flows to Asia. QE2 and QE3 effects were much more muted compared to QE1. It is possible that the recent volatility of capital flows into Asia mainly came precious portfolio investments that are not related to the profuse liquidity provision of monetary authorities in advanced countries. Housing prices have also increased. As for QE tapering, effects can vary. For more vulnerable Asian economies, it is likely that long term interests will go up, search for yield will decrease, credit spreads will expand, and bond rates will fall with respect to U.S. dollar. “China and Singapore, which had healthy reserves and current account surpluses, saw their currencies appreciate, however” (Subramanian 9). Hence, it is concluded that QE has not provoked reserve accumulation and currency manipulation with intense or long-term detrimental effects for Asia in general (Subramanian 11). Works Cited Cho, Dongchul, and Changyong Rhee. “Effects of Quantitative Easing on Asia: Capital Flows and Financial Markets.” ADB Economic Working Paper Series 350 (2013): 1-22. Web. 20 Mar. 2014. Eichengreen, Barry, and Poonam Gupta. “Tapering Talk: The Impact of Expectations of Reduced Federal Reserve Security Purchases on Emerging Markets.” University of California, Berkeley 12 Dec. 2013. Web. 20 Mar. 2014. Fabbri, Brian. “CAMRI Roundtable Discussion: Meeting Summary QE Tapering and Impact on Asia.” Centre for Asset Management Research & Investments NUS Business School 2013. Web. 20 Mar. 2014. Fratzscher, Marcel, Duca, Marco Lo, and Roland Straub. “On the International Spillovers of US Quantitative Easing.” European Central Bank (ECB) Working Papers June 2013. Web. 28 Feb. 2014. Joyce, Michael, Miles, David, Scott, Andrew, and Dimitri Vayanos. “Quantitative Easing And Unconventional Monetary Policy – An Introduction.” The Economic Journal (2012): F271-F288. Web. 28 Feb. 2014. McKinsey Global Institute. “QE and Ultra-low Interest Rates: Distributional Effects and Risks.” McKinsey Global Institute Nov. 2013. Web. 20 Mar. 2014. Morgan, Peter J. “Impact of US Quantitative Easing Policy on Emerging Asia .” ADBI Working Paper Series 2011. Ncube, Mthuli. “The Impact of Quantitative Easing in the US, Japan, the UK and Europe.” African Development Bank 2014. Web. 28 Feb. 2014. Ng, Thiam Hee. “Impact on Asian Bond Markets from Tighter US Monetary Policy.” Policy Brief, Office Of Regional Economic Integration (OREI) of Asian Development Bank (ADB) Aug. 2013. Web. 20 Mar. 2014 Subramanian, Arvind. “International Impacts of the Federal Reserve’s Quantitative Easing Program .” Prepared testimony submitted to the House Committee on Financial Services Subcommittee on Monetary Policy and Trade 9 Jan. 2014. Web. 20 Mar. 2014. Read More