Regulation and ‘after-crisis’ financial futures essay
Basing on Davidson and Blumberg (2010) and Garbade (2011), quantitative easing is one of the unconventional tools of monetary policy, under which the Federal Reserve buys banks’ debt obligations (bonds) of mortgage agencies and US Treasury bonds, pouring into the financial system a certain amount of money. The central bank changes the amount of money in the economy, at the same time adjusting the yield of redeemable securities reducing interest rates, thereby making loans to companies cheaper. In fact, as Garbade (2011) marks, it is the increase of the economy liquidity, which should stimulate its subsequent rapid growth.
Indeed, activating the quantitative easing policy in the midst of the 2008 crisis, in November 2010 and September 2012, today the US economy is showing unequivocal signs of growth. Some critics of the Federal Reserve’s actions, without doubt, want to point out that this economic recovery is artificial. One should not forget, however, that many adherents of these views had previously stated that quantitative easing and zero discount rate would not work at all. Is the program of quantitative easing that useless in reality? On the one hand, the overflow of turnover channels with excess money supply raises the risk of price inflation, causes violation of macroeconomic balance, can destroy incentives for productive work, and enhances social and income inequality in society. On the other hand, increase of the effective demand of the population should pull a recovery of the real economy and the service sector. Below we will try to weigh the advantages and disadvantages of quantitative easing policy and assess their consequences in the long run.
The effectiveness of quantitative easing
As Christophers (2014) reasonably notes, quantitative easing may be used as a kind of insurance that inflation will not fall below the target value. Policy liberalization can stimulate growth through growth of asset prices (stocks and housing), reduction of the cost of credit, as well as reduction of the risk that the actual and expected inflation will decrease. Considering the resistance of the financial market and deleveraging by private individuals, the lack of sufficient monetary easing in recent years would lead to double and triple recession (as it has occurred, for example, in the euro area).
Instead, according to the IMF, the policy of quantitative easing by central banks in developed countries since the financial crisis of 2008 led to reduction of systemic risk after Lehman Brothers bankruptcy. In particular, QE2 has boosted the stock market in the second half of 2010, which in turn led to an increase in consumption and strengthening of the US economy, and slowing the fall in GDP growth at the end of 2010 (Garbade, 2011). Thus, GDP growth in the third quarter of this year amounted to 3.5%, in the second quarter – 4.6%. After several years of an insufficient number of jobs, the US labor market is also coming to life. Now the average of 241 thousand new jobs appear in the United States per month, which is almost 25% higher than the monthly average in 2013 equal to 194 thousand (Christophers, 2014). In addition to increasing employment in the economy, the Federal Reserve System points to the growing volume of investments and moderate growth in consumer demand.
Risks of quantitative easing
On the other hand, quantitative easing may lead to higher inflation than expected, if the amount of the required easing proves to be overrated, and too much money is issued (Davidson & Blumberg, 2010). For example, since the beginning of economic recession, the size of the Fed’s balance sheet assets has increased five-fold – from $900 billion to $4.5 trillion (for comparison, China owns US Treasuries for $1.3 trillion) (Christophers, 2014). In addition, this policy can fail if the banks are reluctant to lend to small businesses and households to stimulate demand. It is also necessary to take into account that quantitative easing can effectively mitigate the process of deleveraging reduction, and thus reduce the yield on debts, but in the context of a global economy low interest rates may lead to stock bubble in other economies (Garbade, 2011).
Along with that, increase in the money supply leads to devaluation of the local currency against the others. This feature of QE helps the country’s exporters and debtors whose debts are denominated in local currency, as the debt is devalued with the currency. However, it directly harms the country’s creditors, because the real value of their savings falls. Currency devaluation also hurts importers since the prices of imported goods increase (Dizikes, 2010).
In general, increase in the money supply has an inflationary effect, which manifests with a certain time lag (Davidson & Blumberg, 2010; Garbade, 2011). Inflation risks can be relived if economic growth exceeds the growth in the money supply associated with easing. If production in the economy increases due to the increased supply of money, productivity per unit of money can also increase even if the economy receives more money. For example, if the stimulated growth of the GDP grows at the same rate as the value of monetized debt, inflationary pressure will be neutralized. This can happen if the banks lend credits and not accumulate cash.
On the other hand, if money demand is highly inelastic with respect to interest rates or interest rates are close to zero (symptoms of liquidity trap), quantitative easing may be used for the growth of the money supply, and GDP of the economy is below potential possible level, inflationary effect will be little if any at all (Dizikes, 2010; Garbade, 2011).
Conclusion
If we consider the quantitative easing as inflation tax to stimulate final demand, we can recognize that in many ways this pattern has given a certain effect. Naturally, the recovery in global economic activity has been accompanied by the effect of low base of the crisis period and the replacement of the commodity stock, but the process of inflation definitely worked. However, in our view, the continued growth of inflation threatens by the implementation of stagflation scenario in the short term and definitely opposes the introduction of the next round of unconventional measures of monetary policy. Obviously, the measures of single quantitative easing cannot resolve long-term problems, such as high fiscal deficits, rising unemployment, and so on. Monetary incentives are not able to solve the problems that have arisen in the process of transformation of the credit crisis in recent years in social tension, as can be seen on example of peripheral euro zone countries. At the same time, quantitative easing allows keeping the credit markets in shape, stimulates money supply, relieves the large debt burden of the state, corporations and households, and can be effective as a short-term measure that should be timely deactivated. In the current situation of uncertainty of the reliability and long-term economy strengthening values, we can only hope that the recent decision on the Federal Reserve to terminate quantitative easing is exactly the timely measure. So far, this process is not uniform: the price of risky assets, primarily stocks and commodities, by large already include the completion of quantitative easing, while bond markets are yet to face a serious test of strength in the future.
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