Quantitative easing: here to stay

April 2013 | FEATURE | ECONOMIC CONDITIONS

Financier Worldwide Magazine

Quantitative easing (QE) polarises opinion. Advocates of the strategy point to its many benefits, suggesting that it has helped to lower unemployment rates, stimulate economic growth, increase liquidity for commercial banks (which should, in turn, lead to increased lending) and prevent deflation.

Conversely, critics have likened QE to a drug, reducing financial markets to ‘junkies’ awaiting their next fix. This criticism appears all the more relevant when we consider the rapid drop in global markets following the release of the minutes of the US Federal Reserve’s January meeting on 20 February. Those minutes revealed that Federal Reserve officials were unsure of how long to continue with QE. The fall in the markets provides a clear demonstration of Wall Street’s dependence on the monetary policy.

Many investors who have witnessed a strong rally in the markets since mid-2012 were unsettled by the notion of QE being withdrawn in the near future. Todd Schoenberger, managing partner of Landcolt Capital, noted “What Wall Street wants to hear is an absolute sign that the Fed will continue with QE for the indefinite future. When it says we may end it faster, that just raises the uncertainty and the market hates that.”

The Federal Reserve is in the midst of its third round of QE (QE3), which was announced in September 2012. The Federal Reserve is currently buying $40bn a month of mortgage backed securities until such time as the labour market has significantly improved or the expected inflation rate rises above 2.5 percent. On 12 December it was announced that Q3 was extending to $85bn a month by adding $45bn a month of longer term Treasury securities. As a result of QE3 and QE4 the Federal Reserve’s balance sheet now stands at $3.078 trillion.

Despite the growing opposition to the implementation of QE schemes, those in positions of power on both sides of the Atlantic support the policy. The Federal Reserve’s chairman, Ben Bernanke, and outgoing Bank of England governor, Mervyn King, are both strong advocates of the policy.

In late February, Mr Bernanke was forced to defend QE to the House’s Financial Services Committee. When asked about how QE is “eating the lunch of our seniors who can’t fill up their tanks”, rapidly inflating asset bubbles, and helping Wall Street at the expense of average Americans, Mr Bernanke stated that the best way to raise interest rates is, paradoxically, to keep them low. Mr Bernanke noted that keeping interest rates low supports stronger economic growth. He also admitted that while asset bubbles are an inevitable and negative side effect of low interest rates, he believes those low rates and government asset purchases have had a positive effect on the US economy. “Keeping longer-term interest rates low has helped spark recovery in the housing market (and) had led to increased sales and production of automobiles and other durable goods,” he noted.

Mr King also believes that QE is the way forward for the stagnating UK economy. On Wednesday 20 February, the minutes of the Bank of England’s monetary policy committee were released showing that Mr King voted with his colleagues David Miles and Paul Fisher in favour of an additional £25bn in QE. Mr King lost the vote by six votes to three, but he is championing additional QE in the hope that it will help weaken the pound to such a point that exports will lead the country out of the economic doldrums. Mr King and his colleagues argued that further action is required in order to stimulate activity which is needed to avoid “potentially lasting destruction of productive capacity and increases in unemployment”.

Opponents within the bank noted that they had already provided “substantial” stimulus to the economy, while also noting their concern that QE was becoming less effective. With inflation already above the government’s 2 percent inflation target, there is a risk that further asset purchases could send the wrong signal to the public. However, the subsequent loss of the UK’s vaunted AAA credit status may prompt QE’s opponents within the bank to change their stance in the coming months.

Critics of QE in the US in particular, have noted that the policy may in fact hinder growth of both GDP and employment. Indeed, during the fourth quarter of 2012, growth of nominal GDP (NGDP) – a key growth target of quantitative easing – slowed dramatically. NGDP fell from 5.78 percent in Q3 to 0.46 in Q4 2012. Furthermore, the growth of total employment in the US was 526,000 during Q3 2012. The figure dropped to 331,000 in Q4. Unemployment during the first four months of QE4 also rose from 7.8 percent to 7.9 percent. Despite this, and regardless of the many reservations of economists and analysts, quantitative easing, it would seem, is here to stay.

Richard Summerfield