Quantitative Easing And Its Implications On Global Economy

How Quantitative Easing works

Required: Write an essay to address the following statement:

“The QE has been successful in stimulating the economy globally since 2008 and nothing to worry about or the whole QE is a toxic scenario which allowed asset prices to rise to unsustainable level which will result in a catastrophic financial time bomb waiting to explode”. Discuss the statement based on your understanding of QE.

The global economy, over the years, have experienced significant dynamics, much of which can be attributed to the interactions of the demand and the supply side players, the policy frameworks of the economies across the world and the financial behavioral patterns of the people involved. The economy of each country, irrespective of its nature (that is, whether it is a public economy, a market economy or a mixed one), works under certain policy framework, which plays a key role in determining and controlling the dynamics of the economy, though the extent of its control can vary (Mankiw 2014). The economic policy framework in general consists of two types of policies, the fiscal policies and the monetary policies. While the fiscal policies, in an economy, deals with the taxing and public spending in the economy, the monetary policies deal with the market interest  rates, the supply of money and other monetary variables and are in general designed and implemented by the monetary authorities of the countries (Agénor and Montiel 2015).

The monetary authorities of a country design and implement the monetary policies according to the needs of the economy and the trends of economic growth, which the concerned country shows. In general, expansionary monetary policies are taken by the monetary authority of an economy to increase the money supply and the economic and productive activities, thereby stimulating the economy, while the contractionary monetary policies are taken to reduce money supply and the overall economic activities in the country (Schmidt 2013). In this context, one of the most popular expansionary monetary policies in the contemporary global economic scenario, which have been implemented in many significant economies across the world, including Japan, the United States of America and the United Kingdom, is the policy of quantitative easing.

Keeping this into consideration, the essay tries to discuss the aspects of quantitative easing in details, critically examining its implications on the global economy. The essay highlights the benefits as well as the threats, which the economies face from the implementation of quantitative easing, in the global framework, supporting the assertions with economic concepts and empirical evidences available from the economic trends of the countries across the world.

Benefits of Quantitative Easing

The term “Quantitative Easing” refers to one of the most significant expansionary monetary policies, which have been implemented by many significant economies in the world, with the primary aim of stimulating the economy and to spur the overall economic growth of the concerned countries. The main mode of operation of this expansionary monetary policy, by which it tries to increase the activities in an economy, is by lowering down the rate of interest prevailing in the market (Fawley and Neely 2013). The main notion behind the reduction of the market interest rate, which works behind the implementation of the quantitative easing strategy, is that a low interest rate makes it easy for the businesses in the economy to borrow money, which in turn helps the businesses to expand. This in turn, increases the overall productivity of the country, thereby stimulating both the aggregate demand as well as the aggregate supply of the country, thus, taking the economy to the path of sustained growth (Joyce et al. 2012).

In the contemporary periods of economic stagnation, when the economies need a stimulus to gain back pace in its path of progress, many a times, the central bank provides the stimulus in the form of expansion of its open market operations. The central bank of the concerned economy, buys securities from the other member banks, which in turn increases the liquidity in the capital market, thereby increasing the money supply. The fall of the rate of interest, under the quantitative easing policy, allows the banks to lend more, which on one hand increases commercial investments by making money borrowing easier for the businesses in the economy. On the other hand also increases the aggregate household demand in the economy by giving easy credits to them, which in turn increases their demand for the goods and services (Kapetanios et al. 2012).

The other notion based on which the quantitative easing policy works is that, the increased money supply under the operational framework of this policy, helps in lowering the currency value of the concerned country low. This thereby makes the stocks of the country more attractive to the investors from other counties, which increases the Foreign Direct Investment in the country, adding to its economic stimuli (Martin and Milas 2012). The exports of the country also become cheaper, which increases trade prospects of the country in the international scenario and contributes positively in the economic growth of the country.

Threats of Quantitative Easing

The Bank of Japan first implemented quantitative Easing, as a full-fledged monetary policy, in the Japanese economy, in the early 2000s. The policy was mainly taken by the bank, to combat the situation of a long persisting deflation and stagnant economic situation in the country.  The Bank of Japan took the quantitative easing strategy by infusing excessive liquidity in the commercial banks of the country, by providing them with large excess reserves stocks, which ensured less risks of shortages of liquidity. Increasing number of public bonds was bought by the BOJ, thereby helping to keep the market interest rate to zero (Pesaran and Smith 2016).

Though Japan was the first economy to implement this strategy, their footsteps was followed by the most influential global economies like that of the United States of America as well as the UK and the Euro zone at the times of the Global Financial Crisis. The Crisis occurred in 2007-2008 and had long lasting implications (mostly negative) on almost all the significant economies of the world. The Financial Crisis, during that period, led many of the economies in the global framework to a severe state of stagnancy by decreasing the overall economic and productive activities of the countries (Blinder 2010). In such scenarios, it became immensely important for the countries to stimulate the economic growth in the country to alleviate the crisis. Quantitative easing as an expansionary monetary has been existing in the policy frameworks of UK and USA since then as an instrument for increasing money supply, decreasing the rate of interest and increasing the overall borrowings , thereby facilitating production and consumptions in the economies (Christensen and Rudebusch 2012).

The policy had mixed effects in the economies, with significant presence of benefits as well as several threats, which are discussed in the following sections of the essay.

The primary benefit of the expansionary monetary policy of quantitative easing is the considerable lowering of the market rate of interest in the concerned economy. This happens due to the excess flow of money supply, which makes the lending institutions to compete with one another, thereby pulling down the rate of interest prevailing in the market. This in turn benefits the economy by increasing borrowing, investment, consumption and the overall productivity of the economy. The empirical evidences of the economy of the USA have supported this, as the country experienced a noticeable growth in its GDP after the implementation of the quantitative easing policy, as can be seen from the following figure:

Figure 1: Rate of Interest and GDP of the USA under Quantitative Easing

(Source: Tradingeconomics.com, 2018)

The increase in the productivity and the overall economic activities of the country under the effects of the quantitative easing policy, leads to the increase in the scopes of jobs as the employers keep looking for employees to expand their businesses, facilitated by the easy borrowing mechanisms and low interest rates. This thereby helps the economies to keep the level of unemployment low. The economies of the USA and the UK, in the face of the Financial Crisis, experienced the credible threats of prolonged unemployment in the economy. There were also evidences of alarming rate of unemployment in the periods of the Great Depression of 1929, which increased to as high as 40%. However, in the period of Financial Crisis of 2008, the implementation of Quantitative Easing in economies of the USA and the UK helped in preventing the rate of unemployment to rise and stay high for a prolonged period of time by creating enough economic activities, especially in the short run.

Figure 2: Unemployment in the USA

(Source: Tradingeconomics.com, 2018)

As is evident from the above figure, the huge surge in the rate of unemployment, which took place in the economy of the USA with the initiation of the Financial Crisis of 2008, was combated considerably by the Quantitative Easing process. It managed to increase the economic productivity of the country and thereby made the negative implications of the huge unemployment short spanned. The same was seen to reduce visibly over the years as the monetary authorities of the country implemented multiple rounds of QE (Hausken and Ncube 2013).

Apart from the above benefits, the implementation of the QE policy also have positive impacts on the economies in terms of decrease in the toxic assets of the economies, fast and effective results in the face of acute crisis and also in terms of increased scope of the governing authorities of the countries in intervening and fixing the situations. This, if left in the hands of the free markets can lead to even more distortions and negative implications (Maggio, Kermani and Palmer 2016). The positive effects of the quantitative easing have been prominent in the significant economies like America, Europe and the UK, which indicates towards the fact that the policy is significantly effective in most of the cases to combat the situations of economic and financial crisis and productive stagnancy in the economies. However, there are several drawbacks and threats, which the policy poses, and there are empirical evidences supporting these negative aspects, which are discussed as follow.

The primary threat of the implementation of the quantitative easing policy in the contemporary global framework is the threat of formations of extensive asset bubbles in the economy. This is caused due to the excess supply of money as well as the ease of borrowing, which on one hand makes investing on assets easy and on the other hand contributes in increasing economic productivity, thereby increasing employments, salaries and the aggregate demand for assets. Most of the times the asset bubbles are created in the housing or real estate market as this market pose as a lucrative form for alternative investments for the households as well as the investors. The presence of excessive income or money in their hand leads to increasing demand for these assets, which in turn keeps, on increasing the price of such assets as the supply for the same cannot be expanded rapidly or unlimitedly (Blanchard, Dell'Ariccia and Mauro 2013). This in turn created a bubble in the asset markets of the economy implementing quantitative easing. The asset bubble can however burst with a sudden crash in the market prices of those assets, which in turn can have hugely negative implications on the society in terms of significant transfers of wealth, defaulting and bankruptcy (Tropeano 2012).

There are evidences of the risks of such housing bubbles in the contemporary economic scenario. In the last few years, the housing markets are found to be overheating in the economies of Germany, UK and Norway, much of which can be attributed to the quantitative easing policy that has been taken up by the European Central Bank. The policy of the bank of buying euro-dominated assets of almost 60 million Euros every month has led to the dip in the value of the government bonds of the countries, which is making the asset market more lucrative for the investors, thereby raising the prices of the housings, which can be seen from the figure below:

Figure 3: Increase in the housing prices over the years

(Source: Moodys.com, 2018)

Thus from the above figure, it can be asserted that under the policy of quantitative easing, there remains a threat of creation of bubbles in the asset markets, which if burst can lead to immense negative implications for the markets as well as for the economy as a whole (Claeys and Darvas 2015).

Conclusion

From the above discussion, it can be ascertained that, quantitative easing as an expansionary monetary policy has gained immense popularity across the significant economies, especially post the Financial Crisis Period (2007-2008), due to its prospective abilities of taking the economies out of stagnancy or recessionary situations. The policy has shown some robust effectiveness in the economies across the world, as is evident from their GDP and other economic growth statistics. However, the presence of such policy has the potential to create asset bubbles in the economies, as is evident from the potential bubbles created in different economies in the contemporary period. This in turn, has the threat to burst which can take the economy down again on the path of monetary imbalance, distortions, stagnations and bankruptcy

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