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There are numerous strategies that the state authorities can implement to revive the country’s economy when it experiences a recession or is at risk of falling into depression. One of the most wide-spread solutions of today is a strategy called quantitative easing (QE) (Jarrow and Li 287).
In most general terms, quantitative easing is a monetary policy that presupposes that central banks massively expand their open market operations or, in other words, start to flood the economy with the increased money supply. This is aimed to stimulate economic growth and prevent it from a possible collapse (Jarrow and Li 287). Consumers are provided with more money to increase their spending on goods and services – this buying power makes it possible for the government to sustain low-interest rates (which allow banks to give more loans), but at the same time puts the country under the risk of inflation. The process is performed in the following way: the central bank that has a unique power of creating credit out of thin air, purchases securities from other member banks, and issues credits in return. The impact produced is quite the same as printing banknotes for saving the economy (Le et al. 87).
However, despite the temporary effectiveness of the strategy, the increase of the money supply can also diminish the value of the national currency and make the country’s exports much cheaper (Olson and Young 65). The paper at hand is going to investigate the reasons the US government decided to resort to QE and dwell upon these and other consequences this policy produces.
Reasons to Implement Quantitative Easing
There are numerous reasons the government can use Quantitative Easing (Karras 2-4):
- QE can assist in reducing unemployment rates. It is often claimed that artificially increasing the amount of money through QE, the government creates new jobs and thereby reduces the number of the unemployed. The logic is linear: businesses that get more money on their hands start growing and face the necessity to expand their staff. Yet, these benefits are rather disputable as nothing guarantees that this temporary need for the workforce can have any visible impact on the unemployment rates in the long run.
- QE encourages money lending at lower rates. Again, this argument logically follows from the fact that central banks reduce interest rates when they purchase treasuries – as a result, financial bodies receive more money, which is supposed to make them more eager to provide loans at lower rates. Such loans, in their turn, increase consumer spending since individuals and businesses are attracted to such a favorable offer.
- QE encourages borrowing by evoking the customer’s interest. As it has already been mentioned, the customer cannot miss the opportunity to make use of an advantageous bargain – this tendency definitely increases borrowing, which helps revive the economy if it is on the verge of a crisis. Yet, the benefit is also dubious: on the one hand, a certain level of debt and leverage is indispensable of any economy, but on the other hand, individuals and businesses are forced to take a debt which they otherwise could have avoided.
- QE increases consuming power. This argument derives from the idea that the more money enters the economy, the more money is available to the consumer for spending. This not only brings profits to various companies and industries but also creates jobs and keeps the stock market running – the effects that taken together ensure the recovery of the economy.
- QE complements interest rates in case they are already extremely low. It is clear that the Fed is capable of stimulating lending by setting the rate of the federal funds low; however, there are cases when the reduction is already impossible as the rate is close to zero. QE is a powerful tool that can increase the supply of funds and help the Fed out.
However, despite the fact that all the arguments seem rather convincing, most of them are effective only in theory and fail to give any real profit. There are a lot of economists who claim that the strategy is ineffective because the advantages it provides cannot last and are fraught with consequences (Duca et al. 117).
Negative Effects of Quantitative Easing
Although the strategy was successfully implemented in several countries, its risks, as well as negative effects it produces, should not be underestimated. QE is subject to severe criticism, mainly for the following reasons (Duca et al. 124-128):
- QE leads to a sharp increase in the inflation rate. Actually, this risk is the greatest as far as QE is concerned and therefore, should be thoroughly considered before the government ventures upon the unconventional financial strategy. The paradox is that the more money enters the economy, the higher prices become. The problem is that while the supply of money grows at an enormous speed, the amount of goods that stand behind this money remains unchanged, which accounts for the fact that they become more expensive. The increased competition exacerbates the situation and results in excessive inflation. This can turn out to be a real disaster for the economy where prices and incomes get distorted and cannot be stabilized after the havoc.
- QE creates trouble with both import and export within the accepted framework of international commerce. The government can surely use newly printed money to buy goods from abroad (which actually means that these products are obtained free of charge). Still, this strategy cannot be applied for a long time: gradually, the exporters get discouraged as they have to tolerate that their goods are exchanged for paper because the importer’s currency devaluates. Thus, they can eventually stop all trading operations until the government puts an end to QE.
- QE undermines the stability of the national currency. The experience of QE implementation reveals that in many cases governments get frustrated with the way the strategy affects the currency. In fact, for many of them it is evident that resorting to QE demonstrates their incapability to foster real economic growth. This may mean that no financial support will be rendered to the country in future as no one is willing to put money in jeopardy.
- QE generates profits that do not manage to last till the end of the strategy implementation. No matter how smoothly QE may run, its success is often delusive: as soon as the central bank stops printing new banknotes, there is a strong chance that the process will go reverse. That is why despite the possibility of ensuring economic growth through consumer encouragement, many economists still believe that the effects of QE are temporary. This idea is proved by the fact that it is not uncommon for the stock markets to fall when the government announces that QE is approaching its end.
- QE may increase the amount of debt. This is another negative consequence the strategy brings about. As it was discussed above, QE intentionally creates a situation in which individuals and businesses are encouraged to borrow money – this contributes to the economic development of the country. However, wanton loans and excessive debt cannot give any positive outcomes (especially when the country reaches its debt ceiling).
Thus, it is evident from the analysis of QE effects that the program is equally capable of fueling the economy and drowning it – any careless step can turn out to be a huge strategic failure. It is not sufficient to elaborate the program – it must also be applied in such a way that long-lasting improvements are achieved (Hsu and I-Chien 3).
The Experience of the US in Quantitative Easing
The policy of QE, which was considered to be rather unconventional only several decades ago, has been gaining popularity during the recent years. At present, practically all central banks across the globe (including the Federal Reserve, the European Central bank, Bank of Japan and others) have already implemented this strategy to save their economies from recession and spur borrowing and spending activity (Duca et al. 132).
In 2008, the US housing market had to encounter the most severe economic collapse since the times of the Great Depression, which quickly engulfed the whole financial sector of the country and immediately infected the world economy, bringing down regular banks, insurance companies, non-bank organizations, mortgage lenders, and other non-government bodies. Both Europe and Asia had to suffer the consequences of the American crisis, which resulted in the overall slowdown of economic development across the globe (Jarrow and Li 293).
While the government still hoped to stop the crisis when it emerged, the Federal Reserve resorted to QE to save the situation. The policy was enacted in several successive rounds. In November 2008, the Fed started to purchase government bonds; it offered to buy app. $100 billion of agency debt and app. $500 billion of mortgage-backed securities, which turned out to be far from its limit in the long run – another $850 billion were spent in 2009 within the same round (also, $300 billion were claimed into long-term treasuries). In 2010, the second round began and by the middle of 2011, $600 billion were spent on long-term treasuries (Duca et al. 133).
In 2011, the Federal Reserved made a decision to launch the so-called Operation Twist, which was intended to increase the maturity of the treasury portfolio – as a result, $400 billion worth of treasuries with maturities 72-360 months were bought whereas the same quantity (however, with maturities between 3 and 36 months) were sold, which, however, did not help prevent the third round of QE. The central bank planned to spend app. $40 billion per month in mortgage-backed securities; however, a year later, it turned out that the Fed would buy a total of $85 billion in long-term treasures (which the Fed intended to cut by $10 billion before finishing the program altogether) (Jarrow and Li 295).
The final purchase was announced no earlier than in 2014, when the securities had already rose from $2.825 trillion to $4.482 trillion and the ultimate goals were achieved: 1) the unemployment rate stopped at app. 7%; 2) GDP growth was stable and amounted to 2-3%; 3) the inflation rate did not exceed 2%. However, the Fed did not exclude the possibility to raise interest rates in case the economic growth continued (Karras 7).
During the global financial crisis, the country was placed in such conditions that it could no longer reduce short-term nominal interest rates (as they had already fallen to the zero point) – that was the major reason the government decided to venture upon a risky QE strategy. Yet, it can be fairly claimed that the US Feral Reserve was successful in undertaking QE, which became the most extensive stimulus program in the economic history (Karras 7).
The Future of Quantitative Easing in the US
Having achieved success with QE for the first time, the country is now trying to repeat it. It is unclear if the new President will want to launch another round but the chances are rather high. Promises to continue the policy come from the President himself. His words are supported by market traders and financial media that expect another wave of economic growth (Duca et al. 142).
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However, the prognosis is not so promising for the Fed. The President’s planned policies (which involve enormous public spending on infrastructure) are likely to aggravate current deficits. This will lead to inflation, with which the Fed will not be able to solve (Duca et al. 143). This time, QE will have to resort to super-easy liquidity to save the situation – however, the success of it is highly doubtful and even the most optimistic analysts cannot promise economic prosperity in the nearest future. QE continues to be a point of controversy: while some economics believe that it can save the country for the second time, others argue that it will lead to its total destruction, from which the nation will never recover. Perhaps, the government will have to look for alternatives in order to avoid recession this time (Le et al. 97).
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Hsu, Feng-Jui, and I-Chien Liu. “Quantitative Easing and Default Probability of Corporate Social Responsibility in US.” Applied Economics Letters, 2016, pp. 1-5.
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