Quantitative Easing: Lessons from History - Assignment Example

BUSINESS ECONOMICS A The Euro zone has experienced slow growth in recent months. Even worse, some of the countries within the Euro zone are in a recession. The economies of the 19 nations comprising the Euro zone are in dire need of stimulus packages. Such packages can help to restore the confidence of investors in the market. Furthermore, the entire region of Europe is confronted with grave deflation stemming from a situation whereby prices have unexpectedly fallen despite a drastic drop in the inflation rate in December 2013. These are the circumstances under which the European Central Bank has aimed to stimulate the stagnating economies of the Eurozone. TThe President of European Central Bank, Mr. Mario Draghi, has revealed ambitious plans for applying Quantitative Easing across the Eurozone in the face of recession and deflation. Deflation has struck the Eurozone thereby slowing down growth and causing drastic fall in prices (Krishnamurthy & Vissing-Jorgensen, 2011, 15-19). Consequently, the Eurozone has come under increased risk of falling into irreversible stagnation. Nevertheless, there has been strong resistance from countries such as Germany against the application of Quantitative Easing within the Eurozone. Quantitative Easing refers to the action of Central Banks creating electronic money and using the cash to acquire low-risk securities such as bonds from banks and other financial institutions. In turn, this lowers the interest rates and encourages people and businesses to borrow more money from financial institutions (Krishnamurthy & Vissing-Jorgensen, 2011, 31-38). As a result, spending on goods increases and employment opportunities rise, thereby boosting the economy. Quantitative Easing has been applied for in countries such as Japan in the 1990s and USA and UK during the 2008 financial turmoil (Hausken & Ncube, 2013, 65-70). The success of QE is stimulating economic growth in the mentioned countries should convince the European Central Bank of the reliability of Quantitative Easing in boosting the dwindling economies of the Eurozone. There are reasons as to why the European Central Bank looks to apply Quantitative Easing within the Eurozone. The first reason concerns the creation of more employment opportunities. The money printed through Quantitative Easing can enable businesses to hire more employees in their operations. The Eurozone will thereby attain the maximum level of employment possible. Another reason for implementing QE by the European Central Bank is the desire to boost lending and foster borrowing. Buying bonds from commercial banks improves their liquidity position. This will motivate banks within the Eurozone to lend money to borrowers at lower interest rates (Krishnamurthy & Vissing-Jorgensen, 2011, 46-54). An increase in loans boosts the economy by elevating the level of business development. Existence of leverage and debt will help the Eurozone to experience economic growth. The European Central Bank also desires to increase the level of spending in the economies of countries using the Euro currency. The increase of money into the economy will stir consumers to spend more on goods and services. From that point forward, businesses will reap an increased level of profits and goodwill. This will lead them to create more employment opportunities and stimulate growth of the stock market. In the final reckoning, these factors will boost the confidence of consumers and spur economic recovery. The European Central Bank also intends to test the practicality of Quantitative Easing as an additional tool of lowering interest rates. The results will enable the ECB prepare to use QE as a measure of last resort. 2.) Quantitative Easing is a technique that reduces the yield of bonds on government debt. It also increases the supply of money in the economy by raising the money reserves of commercial banks. Quantitative Easing can be shown to have several advantages. Quantitative Easing has been credited with boosting previously underperforming economies. For instance, the UK economy experienced enhanced growth in 2010 after the application of QE in response to the global crisis in 2008. If it were not for Quantitative Easing, the country would most likely have suffered a deeper recession (Hausken & Ncube, 2013, 72-74). The application of Quantitative Easing lowers the yield on government debt. Consequently, it reduces the interest rates charged on loans and other financial instruments. This empowers households and businesses by boosting their financial wealth. The rise of equity prices can also increase the revenues of individual companies. The greater the wealth of different enterprises, the greater their ability to increase employment opportunities. Quantitative Easing builds consumer confidence and kick-starts a slumping economy. This was clearly demonstrated when QE was applied in the US and the UK during the global meltdown in 2008. The two mega economies experienced a clearly discernible growth in stock prices and consumer spending. The financial markets reopened, and investors regained the confidence to spend their money in high-risk stocks. Granted, financial authorities in the US and the UK applied Quantitative Easing using different techniques (Hausken & Ncube, 2013, 76-85). However, the boosting effect on the economy was undeniable. Previous successes attained with the application of QE also work towards its favor, especially regarding its implementation within the Eurozone. Nevertheless, there are a few disadvantages associated with Quantitative Easing. As already noted, QE improves the liquidity of banks by boosting the level of cash reserves. This has emboldened some banks to take an increased number of risks. The 2008 financial meltdown is one example of the negative effects that can result from banks taking greater risks (Trefgarne, 2009, 21-36). Additionally, some bond traders have exploited the situation by using the bond market so as to make unprecedented profits from commercial banks. Financing government debt by Quantitative Easing weakens the resolve of governments concerning the reduction of fiscal deficits. Consequently, the public sector debt can rise unchecked up to unmanageable levels. Quantitative easing contributes to currency manipulation. A country may be able to make its exports cheaper by manipulating the value of its currency. However, this is detrimental to other markets whose exports will be rendered less productive. One of the major drawbacks of Quantitative Easing is the creation of inflation. An increase in the supply of money in the economy creates a proportional rise in the prices of commodities such as oil. Rising prices of oil have created cost-push inflation. Quantitative Easing has also reduced the interest rates by great margins. Consequently, the accumulated returns earned from savings have been wiped out. Quantitative Easing has made it impossible for bonds to be sold back to financial markets in future (Moosa, 2014, 32-38). This inconvenience undermines the ability of a country to acquire additional stock in the future. In the long run, this could reduce the progress of economic growth and increase interest rates. Quantitative Easing is only a temporary measure. It neither solves nor allays the underlying fiscal problems. QE has been shown to cause an increase in commodity prices. Excessive importation of goods into the country can have the undesirable effect of inhibiting growth (Moosa, 2014, 41-46). Since QE prompts banks and investors into relatively riskier investments, this can serve to exacerbate the existing recession. The occurrence of inflation will convince investors to sell more bonds than they would customarily. Therefore, it becomes exceptionally hard for both the private sector and the government to refinance their debt instruments. Eventually, an inability to refinance debts may cause widespread bankruptcy. In the event where the central bank is required to reverse the process of pumping money into the economy, asset prices will experience intense downward pressure. Entire governments run the risk of falling into shameful bankruptcy. B. 1.) In game theory, a cell is labelled as a Nash equilibrium if the following two conditions are satisfied. First, the initial number in the payoff pair of the cell has to be the maximum value in the column of that particular cell. In addition, the second number of the payoff has to be the highest value of the row comprising the cell (Myerson, 1999, 25). Using these criteria, the Nash equilibria can be established as (C, C) and (E, E). For (C, C), three is greater than zero while two is also greater than zero. For (E, E), two is greater than zero while three is also greater than zero. This means that both economists would be better served to either fully adopt expansionary measures or contractionary measures. Endeavoring to adopt either of the strategies at the expense of another would be counterproductive (Van Damme & Weibull, 1995, 45). 2.) The policy makers have three primary concerns. The first duty involves the development of sustainable economic growth. Another aim of policymakers concerns the creation of employment opportunities. Furthermore, decision makers endeavor to adopt strategies that can ensure stability in prices of commodities. For the two decision makers, the best option is to adopt either expansionary or contractionary policies. This keeps the interest rates low and boosts the levels of borrowing of both individuals and businesses. Different means can be employed in order to enact expansionary policies. The first measure concerns the purchase of treasury bonds in the open market operations. Additionally, the Central Bank can reduce the amount of mandatory reserves it requires banks to maintain. Furthermore, the Central Bank can lower the discount rate by charging banks less whenever they borrow directly from the Central Bank (Myerson, 1999, 39-46). These measures contribute to an increase in circulating money. Moreover, they lower interest rates and boost economic growth. The Central Bank can also buy large quantities of bonds and securities so as to reduce interest rates even further. This allows households to finance additional spending on goods and services. On the flip side, a contractionary monetary policy is aimed at reducing the supply of money in an inflationary economy. The Central Bank steps in to lessen the level of economic activity and raise interest rates (Myerson, 1999, 52-61). This is intended to inhibit the borrowing habits of banks, individuals, and other businesses. The Central Bank can sell government securities, raise the level of required reserves, or increase the discount rate. The two policy makers can use the degree of inflation as a guide to help them decide on deploying either contractionary or expansionary policies so as to attain the desired objectives. References Hausken, K., and Ncube, M.,2013. Quantitative Easing and its Impact in the US, Japan, the UK and Europe. New York: Springer. Krishnamurthy, A., and Vissing-Jorgensen, A., 2011. The Effects of Quantitative Easing On Interest Rates: Channels and Implications for Policy. Cambridge, Mass.: National Bureau of Economic Research. Moosa, I., 2014. Quantitative Easing as a Highway to Hyperinflation. Hackensack, N.J.: World Scientific Publishers. Myerson, R. B., 1999. “Nash Equilibrium and the History of Economic Theory”. Journal of Economic Literature, 37 (3), pp. 1067-1082. Estados Unidos: American Economic Association. Trefgarne, G., 2009. Quantitative Easing: Lessons from History. London: Centre for Policy Studies. Van Damme, E., and Weibull, J. W. 1995. "Equilibrium in Strategic Interaction: The Contributions of John C. Harsanyi, John F. Nash, and Reinhard Selten." Scandinavian Journal of Economics, 9 (7), pp. 15-40. Read More