Quantitative Easing: A Critical Analysis

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Quantitative easing is viewed by many as a good infusion of economic activity and funds into a stagnant economy. It is seen by many of those same people as a means to prop up or even incur growth in an economy in much the same way as other cash infusions such as tax credits to consumers and/or businesses. Quantitative easing, when used, is a Band-Aid at best and is never a long-term solution to economic travails as it cannot replace true organic economic growth spurred by the private sector and can actually cause problems such as inflation, stagflation and other issues in economies that it is used in as well as economies that are influenced by the same.

Definition

The first step in defining the perceived or actual good and bad effects of quantitative easing is to define what it is and why it is done. Essentially, quantitative easing (often shortened to QE) is an atypical way to spur economic growth and recovery when the usual monetary policy tricks and steps are ineffectual or not effective enough. The “usual” method used by governments often entails, or at least includes, the buying and/or selling of bonds. Quantitative easing is different because it involves infusion of cash from long-term investments from commercial banks and/or other private financial industries and institutions. The point is to lower interest rates and thus the yield on the involved financial assets. This lowers the short-term borrowing costs on many short-term loans and credit lines. This can spur growth to start in the economy itself and/or the economies that are closely intertwined with the economy that is being guided via the aforementioned monetary policy, or at least better allow for it (Harada & Masujima, 2009). 

The Good

Quantitative easing is good in that it does tend to lower interest rates for borrowing. If borrowing costs are high, this can be a heavy drain on the economy and can lead to companies in the private sector being very tentative about making discretionary investments and other businesses that must borrow to survive or thrive will be punished by the higher borrowing costs thus pinching their margins if not actually causing a loss due to the interest costs, among other potential factors, to eat away all profits. This mechanism and goal of quantitative easing was proven during the recent Great Recession when the United States, as well as other countries around the world like the United Kingdom and others, did precisely that and interest rates, as well as bond yield percentages, did fall. The news was not all good as the effective government-issued bond rate was close to zero, but there was some efficacy to be measured as well although the level of response did vary from country to country based on the individual economic levels and traits of each country’s financial and private sector markets (Christensen & Rudebusch, 2012). 

The use of quantitative easing is not done for most recessions and global crises and this is mostly because most economic downswings are fairly short in nature, two years or less, and can be solved using measures much lesser than quantitative easing. However, the recent “Great Recession” in the United States and the wider global economic crisis was easily the nastiest global economic problem and even since the Great Depression and other global struggles in the 1930’s. As such, extensive interventions were needed in many countries including the United States and a lot of the countries resorted to quantitative easing to deal with the fallout of the crises, in addition to things like austerity-oriented budget cuts in Greece and so on (Joyce, Miles, Scott, & Vayanos, 2012). 

Indeed, short-term interest rates is not the only economic trait of a country that influence whether a country’s private sector grows and expands, as the recent Great Recession in the United States proved in spades as economic growth has been positive but lumbering since 2009, but the effects that are measurable from quantitative easing have been mostly positive through the three rounds of quantitative easing that have been done in the United States from 2007 to the present day. The rate influence leads to a clear disconnect between market rates and actual rates. Depending on the manifestation, this can be good or bad but so long as the rates are lowered at least in the short term, the economy tends to reactive positively as the cost of borrowing is less. Again, it’s a “Band-Aid” approach and cannot be relied on in perpetuity, but it has a purpose that is well-intentioned and is generally more effective than it is non-effective (Joyce et al., 2012).

The Bad

Even with all the positive effects, or at least mitigation of bad ones, of quantitative easing, it should be used with great care and it is not a fix-all even when economic times are exceedingly bad. For example, it was found in multiple countries around the world that engaged in quantitative easing, both during the 2007-2009 economic crisis and during crises prior to that, that effective interest rates to quell economic strife is actually negative interest, which is obviously counter-intuitive to a loan product because the person borrowing the money pays the bank a fee, even if it’s nominal, as a consideration for being given access to the money. It is not uncommon for governments to use credits or rate reductions on taxes to incur growth, but that is a whole separate process from borrowing money from a lending institution (Joyce et al., 2012). 

Indeed, quantitative easing is often not effective when there are active trends in the economy related to credit constraints, limited financial market participation or distortionary taxes. This was easily seen in the United States economy from 2008 to 2010 when the mortgage lending market dried up severely as home prices plummeted, zero-down mortgages basically evaporated, down payments other than that went up and many consumers simply elected not to make home purchases or sales while the market was in disarray. When things like that are in play, lowering interest rates does not do a huge amount of good because the general climate of borrowing and lending is severely limited for reasons that have little to nothing to do with interest rates.  For example, if a bank has lost a ton of money on bad mortgages and car loans, they will be less inclined to lend out money, even to qualified borrowers, due to the risk of going further into debt. Another factor is people that lost their incomes or are in fear of the same and this has an effect as well (Joyce et al., 2012). 

As it relates to the United States, some peer-reviewed publications have gone so far as to actively disagree and condemn the assertions and actions of Fed Chairman Ben Bernanke. These critics usually cite the lack of economic growth in countries like the United States that have used quantitative easing as well as the inflation that the quantitative easing ostensibly causes. Combine inflation with an ensuing drop in economic activity, which the United States has thankfully avoided thus far, and one has stagflation. The amount by which a country’s balance sheet is swung by quantitative easing can be massive. For example, the efforts of 2007 to the present made England swing by 40 percent, The European Central Bank by 20 percent and Japan by nine percent. Combine that with Britain’s nominal growth rate of 1.5 percent, Europe by 1.1 percent and Japan’s by decrease by 1.4 percent, it is clear that quantitative easing is a prop and not a fix-all (Nakamae, 2012). 

When looking at currency exchange rates, the proponents for quantitative easing and how aggressive to be when using it is made even more suspect. For example, the United States was much more aggressive than Japan and Bernanke went to so far as to call Japan’s approach “timid”. However, when comparing currency appreciation rates between the United States, who has had three rounds of quantitative easing and thus has been very aggressive, it is clear that Japan’s currency value has increased versus the United States dollar to the tune of five percent. Japan’s growth rate was five percent while the United States was a meager two percent and the European Union and Britain individually were both negative over the same time period. Combine that with the fact that the more aggressive countries like the United States and Britain would make interest rates spike if they try to “exit” the quantitative easing process by selling off the assets that were acquired, the United States and Britain and other countries like it have sort of painted themselves into a corner and must now play out the string until the private sectors of their countries are able to counteract the divestiture of those assets by the government agencies that snapped them up (Nakamae, 2013). 

A particular report reviewed for this literature review and analysis was even more scathing. The Cato Institute says that the use of quantitative easing is the “wrong course” and hurts a lot of needed economic activity and behavior such as economic growth in general, savers of money and other things. Also, some of the assets being acquired and managed via quantitative easing in the United States come from agencies that in large part led to the temporary economic downfall of the United States such as those from Fannie Mae and Freddie Mac who had to be bailed out to the tune of billions of dollars at a time, even if the money was eventually paid back. Indeed, the interest rates in the United States are projected to remain at their current rock-bottom and near-zero levels for at least the next 2-3 years or more. This could obviously change, but the current outlook for economic growth is not all that great. Interest rates being low due to economic activity being sky-high and bustling in nature paint the picture of a strong economy and higher interest rates typically indicate the opposite. However, the joy and happiness is far more fleeting when rates are being artificially influence in any way, shape or form (Malpass, 2013).

The Malpass/Cato treatise (2013) continues by asserting that the main thing quantitative easing does little to nothing to address is job growth, or lack thereof. Indeed, to this very day the unemployment rate in the United States remains above seven percent and the whole “when the United States economy is sick, the world catches a cold” argument still holds as countries are increasingly concerned about the lack of employment and economic job growth in the United States. The amount of government-issued payments in the United States has swelled by nearly half but corporate income has only gone up a little over a fifth over the same period. Even worse, the income of small businesses, sole proprietors and dividend/interest income has not even raised ten percent. In short, transfer payments to the poor and retired are far outstripping the increase incomes from private sector activity and this is a bad trend (Malpass, 2013). 

The trends visible with the banks are noticeably altered as well. Prior to the 2008 financial crisis in the United States, the level of inter-bank loans was $80 billion USD. Nowadays, the outstanding loan value is a mere $10 billion USD. However, it is fair and prudent to note that not all of the economic growth slowness in the last five years has been due to quantitative easing. For example, the aforementioned influence of the United States problems being borne on other countries is actually happening in reverse as well. For example, the European Union’s own economic problems, including the problems of Greece, Spain, Poland and others, is influencing the United States negatively as well. However, inflationary pressures in the United States right now are largely self-inflicted (Malpass, 2013). 

Similar condemnation has been levied against the European Union and their very similar efforts, both in terms of size and scale as compared to the affected and involved economies. Like the prior-covered analysts of the United States’ actions with quantitative easing, the necessity of the quantitative easing methods is not in high dispute but the long-term effects of using this tool in terms of inflation, interest rates, and so forth in absence of organic economic growth is a topic of very hot debate and analysis, even in the scholarly/academic sphere (Templeman, 2012). It is also asserted, both in terms of the UK as well as the United States, that the money supply not being properly managed immediately prior to the global economic crisis that occurred in the 1930’s was a contributing factor to the ensuing economic bloodbath. The traits and facts surrounding the 2007-2009 upheaval were obviously different, but were similar as well. The credit markets in the United States, including the mortgage market in particular, were pervasively filled with worthless loans and related securities and the wider practice of lending money that had no business getting it led to a huge bubble bursting when the loans went belly-up (Cobham & Kang, 2012). 

Another scholarly offering notes that the two “pillars” of economic recovery in recent years, those being quantitative easing and fiscal austerity, are “crumbling” and have been proven to be ineffectual and actually damaging to the future when used at the wrong time and/or to great excess. A manifestation of that would be banks that are much more cash-rich as a result of quantitative easing, among other factors, but the cash is simply being held onto rather than being leveraged, loaned or other used. This particular perspective focuses on the idea that while stamping out government spending through austerity measures and other budget cuts, using quantitative easing in the wrong way or too much is also a bad idea. However, it was noted before that the typically used and typically effective practices relating to monetary policy were not effective and thus this necessitated governmental budget cuts (austerity) and quantitative easing. In the end, the reason for both actions is the same, that being the need to spur and cause economic growth. However, the use of cash infusions and spending in light of a shoddily-performing economy can be seen as a double-edged sword because if the outlays are not effective, governmental debt has gone up, tax revenues are still stagnant and little to nothing has improved. Again, if the artificial props to the economy are used too long and/or too excess and there is no direct or indirect growth in economic growth in the economy to fill the void that will be created when the infusion runs its course, the efficacy of the infusion will be cast in serious doubt (Makin, 2013). 

The reason for the problems being even worse is known as the liquidity trap. What happens in the liquidity trap is that fiscal austerity is often a drain on economic growth in the eyes of many economists. As a result, the desired economic traits and activity that is seen as a reprieve that shows that quantitative easing and bond purchases/sales are not necessary are actually squelched rather than encouraged. Not all economists believe in this entirely as they do not strongly link economic growth/prosperity with government spending. However, it is undeniable that inflation, even if it’s limited to staple/necessity items like fuel and food, can be devastating to a national economy and the poor of a country in particular. Combined with the fact that job growth is usually lagging for the working poor and working class rather than the executives and other well-paid employees, this makes the overall situation all the more worse. The velocity of money stock has been trending down sharply in the United States since 2005 and the cash infusions and budget tweaks have done little to change that aside from a small spike in 2010 that has since been followed by an even greater fall. Overall, the velocity was at 1.9 and got close to 2.0 in 2008 but fell to 1.65 in 2009, went up to nearly 1.7 but has since fallen to 1.5 before flattening out, at least at that time, in early 2013 (Makin, 2013) Even worse, the aforementioned economic devil that is stagflation has come about in many industrialized countries over the last half-decade. While not all the countries experiencing this have engaged in quantitative easing are having this issue, the countries that are having stagflation are being un duly influenced by the actions of economic collectives and/or powerhouses like the United States, the European Union and the member states of the latter like Great Britain (Simos, 2011).

Speaking of inflation that is focused on staple/necessity products, this exact thing has happened with oil prices per the research and assertions of some economists. While some point a finger at Organization of Petroleum Exporting Countries (OPEC) as the culprit of artificially high oil prices, others point to quantitative easing habits of the United Kingdom and the United States, among others. These same economists go on to assert that while exiting quantitative easing may be a little painful on the front end, the long-term results will lead to a more natural economic playing field and will thus allow for positive economic growth (Verleger, 2013).  

The Verdict

On the whole, quantitative easing is a tool in the repertoire that can be used by the economic giants of the world but it should be used only when nothing else is working and the time horizon during which it is used should not be excessive or the least bit perpetual and seemingly unending or something that cannot/should not be ended without dire financial consequences. It is not unlike other cash infusions like the oft-used “stimulus” packages that include tax credits/rate reductions for when economic activity is lacking in nature. Such infusions, not unlike quantitative easing, are just a temporary shot in the arm and support to the economy. However, if the underling concerns and problems of consumers and businesses do not go away, the infusion will be not be all that effective, if it’s effective at all. This coming to pass relative to quantitative easing is especially messy because retracting the funds from the economy, while beneficial over the long term, is typically painful in the short term when interest rates, inflation/deflation and other reactions by the economy come to pass. 

When looking at the United States in particular, that is precisely what is going on. There is a focus on propping up the economy but the other activities and issues in the economy are clearly a drag on business investment and activity. For example, the continual kicking the can down the road that is the debt ceiling/spending spat in Congress and with the President has almost certainly been a drain and a drag on economic activity. Rather than laying out a trend for the coming years, business and even politicians cannot accurately assume about and predict the future because no one knows what spending, tax rates and so forth will be due to the debt ceiling/default potentially coming about and other massive economic disagreements between the Democrats and Republicans. The current debacle with the Affordable Care Act website and the wide law in general has made the waters all the more muddy. 

This stands in contrast to the years after the Bush tax cuts and the second term of Bill Clinton when there was some agreements made about tax rates and budget priorities and then the Congress basically left things alone and let the private sector grow and thrive as it could and should. Indeed, the economy was running like a fine-tuned engine during the late 1990’s and mid-2000’s. It is true that there as the “tech bubble” of the former and the “credit bubble” of the latter, but the economy was purring like a cat even with those issues brewing. 

The point is that the chatter and activity surrounding the economy outside of quantitative easing is not being coupled with quantitative easing and other Federal Reserve measures to get the economy going and keep it going and this is the most likely cause of the United States economy currently being stuck in low gear in many, but not all, respects. Corporations and banks are awash in cash. This is a good thing. However, the fact that they are unable to leverage that cash like they normally would or should in a strong economy is troubling and it is hurting the economy, as illustrated by the research and recent trends and events in the political and international relation spheres. 

The stark dichotomy and polarization between the liberal and conservative factions of the United States federal and state governments is leading to very disparate economic and political reactions to the point that everything has become disjointed, vitriolic and non-productive. The current liberal power structure is committed to heavy government spending as a means to spur or at least uphold current economic levels while conservatives are railing against the exponential growth of government debt and the coming doomsday scenarios with Social Security and Medicare seem to be the early stages of what is going on in Greece right now. 

Conclusion

What is clear is that there is no singular agreed-to solution that both arcs of political thought can come to. At the same time, the continual spending of cash while the economic playing field is ever-changing or at least subject to probably or potentially change is causing businesses and banks to very extremely conservative out of morbid fear of a double-dip recession or other economic problems. That all being said, quantitative easing is a tool that can be used and should be used but only in instances like the 1930’s and 2007-2009 crisis but it should only be used fleetingly and over a short time-horizon. This should be coupled with tax and other economic policy that stimulates organic economic growth. In short, it can and should be used at times but it should be done in a diligent manner and should not be used as a singular solution.

References

Christensen, J. E., & Rudebusch, G. D. (2012). The Response of Interest Rates to U.S. and U.K. 

Quantitative Easing. Economic Journal, 122(564), F385-F414. doi:10.1111/j.1468-0297.2012.02554.x

Cobham, D., & Kang, Y. (2012). Financial Crisis & quantitative easing: Can broad money tell us anything. Manchester School (14636786), 80(S1), 54-76. doi:10.1111/j.1467-9957.2012.02323.x

Harada, Y., & Masujima, M. (2009). Effectiveness and Transmission Mechanisms of Japan's Quantitative Monetary Easing Policy. Japanese Economy, 36(1), 48-105. doi:10.2753/JES1097-203X360103

Joyce, M., Miles, D., Scott, A., & Vayanos, D. (2012). Quantitative Easing and Unconventional Monetary Policy - an Introduction*. Economic Journal, 122(564), F271-F288. doi:10.1111/j.1468-0297.2012.02551.x

Makin, J. H. (2013). QE Undone. International Economy, 27(2), 25-27.

Malpass, D. (2013). The Fed needs to change course. CATO Journal, 33(3), 365-377.

Nakamae, T. (2012). Bernanke's Claims Unfounded. International Economy, 26(4), 4.

Simos, E. (2011). Stagflation in Industrial Countries from Fed's Global Quantitative Easing. Journal of Business Forecasting, 30(4), 36-40.

Tempelman, J. H. (2012, July). Against Quantitative Easing by the European Central Bank. Financial Analysts Journal. pp. 4-6.

Verleger, P. (2013). Oil Prices and The End of QE. International Economy, 27(2), 5.