One of government economic policy measures, Quantitative Easing (QE) draws a serious attention in international financial market with a bold move by Japanese government. The newly elected government in Japan expects QE to stimulate its decade-long deflationary economy. While QE may be effective tool in domestic economy, the ripple effect of QE is necessary to be addressed: increase the volatility of financial market and devalue the currency. Since modern economy is closely interlinked with each other, the effect of QE spreads out across countries and influences international financial system as a whole.
‘Quantitative easing’ (QE) is one of the monetary policies executed by central banks. Central banks execute QE in order to stimulate national economy, when conventional monetary policy has become ineffective. This is especially when the interest rate stays low and stagnated, letting fiscal policy which is an indirect economic policy with controlling federal interest rate ineffective.
While monetary policy controls money supply in market by buying or selling government bonds, QE supplies market liquidity by buying financial assets from commercial banks and other private institutions based on a pre-determined quantity of money. By executing QE, central bank expects that local banks increase the excessive reserve and raise the price of the financial asset bought as well.
Allegedly, Japan’s central bank, Bank of Japan (BOJ), used the terms ‘QE’ for the first time in early 2000s in order to fight against domestic deflation. Even though the implementation of QEs did not turn out to be successful, QE showed a typical effect of expansionary economic policy: fueled money into local commercial banks promoted private lending with abundant level of liquidities. To do so, BOJ purchased more government bonds as well as asset-backed securities and equities, commercial papers etc.
Since the recent financial crisis ignited by Lehman Brothers, United States have undertaken a series of QE executions. The Federal Reserve(Feds) vigorously bought Mortgage-backed securities (MBS) and Treasure Note (T-note) and it reached up to $2.1 trillion in 2010 (QE1). After a couple of months of holding period, the Feds resumed its purchase of additional $600 billion worth Treasury securities by the first half of 2011 due to no sign of economic recovery expected (QE2). Again, the Feds announced QE3 in September 2012. The program included purchasing additional Mortgage-backed securities (MBS) on a monthly basis and maintaining the federal funds rate near zero at least until 2015. In order to make a break thorough, newly elected Japanese cabinet initiated new quantitative easing to fight a consistently depressed economy. BOJ launched open-ended purchase plan, and targeted inflation rate at 2% to prevent steady drop of asset price.
As mentioned earlier, QE can be an alternative economic measure to conventional policies such as monetary and fiscal expansionary measures. Somehow it is also known as the ‘last resort’ of economic policy because QE can only be considered when no other measures are to be effective. As long as QE programs are able to keep the market and economy afloat and maintain the inflation target, the program is considerably worth trying out. Equity markets are expected to react more actively since more liquidity induces investment. However, there are two factors to consider when implementing QE. First of all, Inflation scares. Too much liquidity infused by QEs might shot up the asset price with keeping low interest rate, and eventually cause higher inflation rate. Equity market can also be more volatile. Also, excessive money supply might lead the local currency to be devalued. Evidently, capital will seek overseas market to invest in leveraging the rate gap and better yields. Economically speaking, once local currency becomes devalued, it is beneficial for export-oriented industry taking price advantage in import-oriented foreign markets. Due to close inter-state relations in international economy, significant changes in certain local currencies might cause adverse effects in other countries.
It is quite appreciative that countries implement every possible economic measure to keep their economy going. As unconventional economic measure, QE seems to take a major role in term of reviving the economy these days. As always, any excessive implementation needs to be carefully monitored under control.