What is quantitative easing? ECB pushes the button on a €1.1trn bond purchase programme, but what does it involve? What is quantitative easing? It is also called “printing money”. But rather than dishing out sacks of newly minted coins and notes, central banks use a more complicated process to inject cash into their economies – by buying assets, typically government bonds, from banks or other financial institutions such as pension funds. The hope is that banks will use the extra funds to increase lending to households and businesses. QE is used when central banks run out of other (more conventional) options, such as reducing borrowing costs. At the moment, interest rates are so low globally that further cuts would do little to revive ailing economies. A Swiss coin is seen beneath a euro banknote, A Swiss coin is seen beneath a euro banknote, Photograph: FABRICE COFFRINI/AFP/Getty Images What does it involve? The European Central Bank said it would buy €60bn of public and private sector securities a month from March, until September 2016. Generally, QE involves creating electronic money – rather than actually cranking up the printing presses – and using it to buy government bonds from the market. Willing sellers tend to be commercial banks that can re-cycle the money through loans to companies or consumers in the form of mortgages or car credit. How does it boost economies? Banks that increase their lending using QE funds are expanding the supply of money in the economy. Turning on the money tap allows companies that need overdrafts and short term loans to survive, while others can make investments through longer-term loans. But, as experts point out, the impact of eurozone QE is heavily dependent on the money reaching businesses and households rather than merely flowing to banks’ balance sheets. The ECB also hopes to bolster confidence and push down the value of the euro in currency markets, giving a boost to exporters. Who has done it before? The US Federal Reserve, the Bank of Japan and the Bank of England are three major central banks that have spent trillions on quantitative easing. The Bank of England spent £375bn over three years before it stopped in late 2012, and the Fed reached $4.5tn over more than five years before it brought the curtain down last October. The Bank of Japan is still pumping money into its economy, and even ratcheted up its programme just two days after the Fed ended QE. New York, Black Thursday, October 1929. New York, Black Thursday, October 1929. Photograph: AP Had it been tried before the latest financial crisis? When the Fed and Bank of England embarked on QE in recent years, it was described as unprecedented. This is not entirely true. After the Wall Street crash of 1929 and the subsequent banking crisis, the Fed started buying Treasury bonds on a big scale to keep yields low, beginning in 1932. Then in 2001, Japan had a stab at quantitative easing, after what became known as the “lost decade” of the 1990s, when property prices slumped and banking lurched from crisis to to crisis. And why do it now? The eurozone as a whole has suffered three years of (near) stagnation, with unemployment stuck at double digit levels, and some countries mired in recession. The currency bloc’s economy is 2% smaller than in 2008, and it has slipped into deflation. National governments could embark on a spending spree to boost activity, but most would breach EU borrowing limits. And they cannot agree on a joint fiscal plan. QE supporters say the policy, which long faced opposition from Germany, is badly needed. The ECB is worried about a deflationary spiral, in which households and firms cut spending while they wait for prices to fall further, causing the economy to slump. Has it worked in the past? Dr. Milton Friedman who won the 1976 Nobel Prize for economics. Dr. Milton Friedman who won the 1976 Nobel Prize for economics. Photograph: EDDIE ADAMS/AP Opinion is divided. Evidence suggests that it tends to benefit wealthier households by pushing up asset prices. The Bank of England is convinced that it works, but some critics have expressed doubt that the money got to the parts of the UK economy that needed it most – small businesses. In the US, unemployment fell sharply after QE started but growth rates remained patchy. Some analyses (including those of arch-monetarist Milton Friedman in his book The Great Contraction) contend that the Fed’s efforts in the 1930s were crucial to dragging the economy out of the Great Depression. It’s all about timing: Japan’s efforts in 2001 were widely regarded as too late. Will it work today? Some argue that the ECB should have acted sooner. One problem is that while the US acted quickly to rid its banking system of toxic assets, putting them in a better position to increase lending when QE arrived, the eurozone has not done this. Critics also note that QE will ease the pressure on economies like France and Italy to carry out badly needed structural reforms. Larry Summers, the former US treasury secretary, says QE works best when there is an element of surprise, and scope to reduce bond yields. But bond yields are already very low. The size of the ECB’s QE programme had an “awe” effect even though the central bank had been publicly flirting with QE since last summer. It seems certain that doing nothing would have made things worse. If anything, QE could boost confidence in the eurozone. - The Guardian, Thursday 22 January 2015 theguardian/business/2015/jan/22/what-is-quantitative-easing?CMP=twt_gu&utm_source=newsletter&utm_medium=mail&utm_campaign=newsletter&utm_content=2015-01-23
Posted on: Fri, 23 Jan 2015 11:42:50 +0000
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