Does quantitative easing work?
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Michael Collins is an investment commentator with Fidelity Worldwide Investment.
The Federal Reserve has now conducted three and the Bank of England has boosted the size of its program three times. The Bank of Japan's first one lasted five years and after a four-year break it had another go.
We are talking about episodes of quantitative easing, an ungainly term for an unconventional central-bank weapon. The big question today is whether these asset-buying programs work. Or should central bankers resort to other tactics to revive their economies?
To evaluate quantitative easing, it helps to understand what it is. Quantitative easing, broadly speaking, is a policy option that has its origins in Milton Friedman's assessment that while interest rates were low during the 1930s Great Depression, money policy was still tight because banks had little money to lend.
Quantitative easing is an attempt to inject money into a struggling economy via the banking system when interest rates are already close to zero - as in conventional monetary-policy tools are spent.
The way quantitative easing works in most cases is that a central bank creates electronic money by a pre-set amount that ends up as a liability on its balance sheet. As it does this, it buys the equivalent amount of assets (usually financial assets such as government and corporate bonds) that sit on the asset side of its balance sheet.
The commercial banks and other institutions selling these assets will then have extra money in their accounts with the central bank, which then boosts the monetary base - defined as coins and notes at banks and circulating in the economy, plus bank reserves held by the central bank.
Quantitative easing is not money printing, which is tied to fiscal policy, because it's about putting money in the hands of the public, even if it has a similar effect.
Governments can be said to be printing money when, instead of borrowing from the public, they let central banks finance fiscal deficits or when central banks monetise government debt. (The Treasury's books show a debt to the central bank in these circumstances.)
The distinction is important because it reveals the political advantage quantitative easing offers policymakers - it enables large amounts of money to be available for productive economic use without adding to a government's budget deficit.
Washington's budget shortfall would have jumped to 15 per cent of GDP - Greek levels - if the Fed's second burst of quantitative easing was money printing (and was done within one fiscal year). Imagine the political and financial firestorm if President Barack Obama sought Congress' approval for that, even if the jolt to the economy from such fiscal stimulus would have been huge.
For and against
The aim of quantitative easing is to give banks more money to lend while reducing long-term interest rates for consumers and business. Central-bank asset-buying counteracts deflationary forces and prevents the contraction in the money supply that paralysed economies in the 1930s.
Signs that policymakers are taking decisive steps to help the economy can revive consumer and business confidence. The asset-buying may undermine a country's exchange rate, thereby giving an economy an export boost.
Higher bond prices push more money into equities when institutional investors rebalance and a stock-induced boost to wealth can help consumption.
What can go wrong? Critics warn that these asset-buying schemes foster risky investment, overinflate asset prices, trigger inflation and are ineffective economic stimulus as they fail to boost demand as targeted fiscal stimulus does.
Banks can simply sit on the fresh money rather than lend it. Central banks can lose money for their governments if the value of the new securities on their balance sheets plunges. There are doubts about how easily these programs can be unwound.
Trading partners may regard the export boost these programs give a country as the start of a currency war - that's how China reacted to the Fed's second serving. The fact these programs have an intended end can be self-defeating. Even if they do any good, these programs face diminishing returns if extended.