Quantitative easing
From Wikipedia, the free encyclopedia
Quantitative easing is a monetary policy to increase the money supply by a pre-determined quantity via open market operations. It is distinguished from the more usual practice of setting a target for a specific interest rate (such as the federal funds rate) and continuously adjusting the amount of money to achieve that target. Central banks switch from interest rate targeting to quantitative easing when the interest rate is zero and they want to ease further.
The new money is created ex nihilo by a central bank as the start of a process to increase the money supply. It is injected into the private banking system when the accounts of the vendors of the securities purchased by the central bank through the open market operations are credited.
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[edit] Concept
In layman's terms, quantitative easing refers to the creation of a significant amount of new money (usually electronically) by a central bank. This money is created to stimulate the economy, in particular to promote lending by banks. The central banks add cash by buying up large quantities of securities from banks, giving them new money to lend. These securities could be government bonds, commercial loans, asset backed securities, or even stocks. Quantitative easing is usually used when lowering official interest rates is no longer effective because they are already close to or at zero[1].
'Quantitative' refers to the fact that a specific quantity of money is being created; 'easing' refers to reducing the pressure on banks.[2] A central bank can do this by using the new money to buy government bonds (treasury securities in the United States) in the open market; or by lending the new money to deposit-taking institutions; or by buying assets from banks in exchange for currency; or any combination of these actions. These have the effects of reducing interest yields on government bonds and reducing interbank overnight interest rates, and thereby encourage banks to loan money to higher interest-paying bodies.
Banks use a practice called fractional-reserve banking whereby they abide by a reserve requirement, which regulates them to keep a percentage of deposits in 'reserve'. The remainder, called 'excess reserves', can be used as a basis for lending. The increase in deposits from the quantitative easing process causes an excess in reserves and private banks can then, if they wish, create even more new money out of 'thin air' by increasing debt (lending) through a process known as deposit multiplication. The reserve requirement limits the amount of new money. For example a 10% reserve requirement means that for every $10,000 created by quantitative easing the total new money created is potentially $100,000. The US Federal Reserve's now out-of-print booklet Modern Money Mechanics explains the process.
A state must be in control of its own currency if it is to be able to unilaterally employ quantitative easing. Countries in the eurozone (for example) cannot unilaterally use this policy tool, but must rely on the European Central Bank to implement it.
Willem Buiter has proposed a terminology to distinguish quantitative easing, or an expansion of a central bank's balance sheet, from what he terms qualitative easing, or the process of a central bank adding riskier assets onto its balance sheet:
Quantitative easing is an increase in the size of the balance sheet of the central bank through an increase it is [sic] monetary liabilities (base money), holding constant the composition of its assets. Asset composition can be defined as the proportional shares of the different financial instruments held by the central bank in the total value of its assets. An almost equivalent definition would be that quantitative easing is an increase in the size of the balance sheet of the central bank through an increase in its monetary liabilities that holds constant the (average) liquidity and riskiness of its asset portfolio.
Qualitative easing is a shift in the composition of the assets of the central bank towards less liquid and riskier assets, holding constant the size of the balance sheet (and the official policy rate and the rest of the list of usual suspects). The less liquid and more risky assets can be private securities as well as sovereign or sovereign-guaranteed instruments. All forms of risk, including credit risk (default risk) are included.[3]
[edit] Aims
The aim of quantitative easing and the follow on process of deposit multiplication is to increase the amount of money in circulation by an increase of credit and thus stimulate the flow of money around the economy by increased spending. The usual method of regulating the money supply is by setting interest rates. Quantitative easing is a solution when the normal process of increasing the money supply by cutting interest rates isn’t working. Most obviously when interest rates are essentially at zero and it is impossible to cut them further.
[edit] History
Quantitative easing was used notably by the Bank of Japan (BOJ) to fight domestic deflation in the early 2000s.[4] More recently during the global financial crisis of 2008, policies announced by the US Federal Reserve under Ben Bernanke to counter the effects of the crisis are a form of quantitative easing. Its balance sheet has expanded dramatically by adding new assets and new liabilities without "sterilizing" these by corresponding subtractions. The United Kingdom is also currently using quantitative easing as an additional arm of its monetary policy in order to alleviate its own financial crisis.[5][6][7]
The European Central Bank has been using quantitative easing (though it does not refer to it as such) through a process of expanding the assets that banks can use as collateral that can be posted to the ECB in return for Euros. This process has led to bonds being 'structured for the ECB' [8]. By comparison the other central banks were very restrictive in terms of the collateral they accept: the Fed used to accept primarily treasuries (recently it has been buying almost any relatively safe dollar-denominated securities); the Bank of England applies a large haircut.
In Japan's case, the BOJ had been maintaining short-term interest rates at close to their minimum attainable zero values since 1999. With quantitative easing, it flooded commercial banks with excess liquidity to promote private lending, leaving them with large stocks of excess reserves, and therefore little risk of a liquidity shortage.[9] The BOJ accomplished this by buying more government bonds than would be required to set the interest rate to zero. It also bought asset-backed securities and equities, and extended the terms of its commercial paper purchasing operation. [10]
[edit] Risk
Quantitative easing is seen as a risky strategy that could trigger higher inflation than desired or even hyperinflation if improperly used and too much money is created. However, some economists argue that there is less risk of this outcome when a central bank employs quantitative easing in order to ease credit markets (e.g. by buying commercial paper), as opposed to buying the government's debts (treasury securities) which allows Congress to spend more than its revenue without risking default on its financial obligations.
[edit] See also
- Fiat currency
- Credit money
- Debasement
- Economic history of Japan
- Economy of Japan
- Fractional-reserve banking
- Open market operations
- Money supply
- Money creation
- List of economics topics
- List of finance topics
[edit] References
- ^ "Q&A: Quantitative easing". BBC. 2009-03-09. http://news.bbc.co.uk/1/hi/business/7924506.stm. Retrieved on 2009-03-06.
- ^ "Guardian Business Glossary: Quantitative Easing". The Guardian. http://www.guardian.co.uk/business/2008/oct/14/businessglossary. Retrieved on 2009-01-19.
- ^ Willem Buiter (2008-12-09). ""Quantitative easing and qualitative easing: a terminological and taxonomic proposal"". http://blogs.ft.com/maverecon/2008/12/quantitative-easing-and-qualitative-easing-a-terminological-and-taxonomic-proposal/. Retrieved on 2009-02-02.
- ^ Mark Spiegel. "FRBSF: Economic Letter - Quantitative Easing by the Bank of Japan (11/02/2001)". Federal Reserve Bank of San Francisco. http://www.frbsf.org/publications/economics/letter/2001/el2001-31.html. Retrieved on 2009-01-19.
- ^ The Unthinkable Has Happened
- ^ ‘Bernanke-san’ Signals Policy Shift, Evoking Japan Comparison, Bloomberg.com, 2008-12-02
- ^ Bank pumps £75bn into economy, ft.com, 2009-03-05
- ^ [1], IFLR, 2009-20-02
- ^ Easing Out of the Bank of Japan's Monetary Easing Policy (2004-33, 11/19/2004)
- ^ PIMCO/Tomoya Masanao interview
[edit] External links
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Look up quantitative easing in Wiktionary, the free dictionary. |
- Stimulus Watch, website tracking all measures taken by the Federal Reserve and other government agencies to address the financial and economic crisis
- Deflation: Making Sure "It" Doesn't Happen Here, 2002 speech by Ben Bernanke on deflation and the utility of quantitative easing
- Modern Money Mechanics Federal Reserve Document explaining how money is created
- Quantitative easing explained (Financial Times Europe)
- A basic guide to quantitative easing (Economonkey)
