What is QE, and how does it work? What is your assessment of the effectiveness of the quantitative easing policy in the UK and the US? Evaluate the empirical evidence of QE in these two countries? In your view which country QE was more effective in helping the real economy US or UK, and why?
Quantitative easing can occur in different ways, but the majority of the time the central banks will use it to create money within the central bank in order to buy financial assets (Carlin and Soskice, 2015). It can be described as an unconventional policy because the lever it uses varies to what has been used in previous inflation-targeting monetary schemes, using these unconventional policies aid central banks stabilise their levels of demand and allow them to not miss their targets set in place for inflation (Carlin and Soskice, 2015). Quantitative Easing can be seen as a ‘last resort’ to prompt activity in the economy in times of a recession (Tsujimura and Tsujimura, 2018). Quantitative easing policies can also influence the market expectations of interest rates in the future which can have an impact on the interest rate term structure (Ashraf, et al., 2017). The policies used in Quantitative Easing works by purchasing different assets from the financial markets and institutions with the purpose to increase liquidity within the markets (Ashraf, et al., 2017). QE works by purchasing government bonds and other financial assets, this results in an increase in demand for them, resulting in the price of these assets being pushed up and decreasing the interest rate (Carlin and Soskice, 2015). In this essay, the effectiveness of QE policies in the UK and the US will be analysed. Before the financial crisis in 2008, Japan was one of the only countries to have used quantitative easing in their monetary policy, however the US and the UK have brought forward both positive and negative impacts of using these policies to stimulate economic activity.
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Due to the financial crisis of 2007-2008 the UK’s Bank of England introduced quantitative easing policies in order to increase the country’s liquidity and stimulate their economic growth. This started with the Monetary Policy Committee gradually cutting their policy rate, this was done in five stages, starting at 5% in October 2008 falling to 0.5% in March 2009 (Joyce, et al., 2011). As the government has lowered their policy interest rate to its zero-lower bound, there was weak economic growth predicted causing the risk that they would be below their 2% target rate for inflation (Christensen and Rudebusch, 2012). Also, in March 2009 the Committee announced that they would be purchasing up to £75 billion of assets with long maturity dates up to 25 years, there was a considerable reaction to the yields with maturities of 15-25 years decreased by up to 80 basis points (Joyce, et al., 2011). However, these securities with long maturities their overnight index swap rates did not fall at the same rate and only decreased by a small proportion (Christensen and Rudebusch, 2012). In the UK, the purchasing of bonds through quantitative easing policies consisted mainly of government bonds but did also include private sector securities, with the purpose of improving the liquidity in the economy (Carlin and Soskice, 2015). The selling of private sector corporate bonds will have led to businesses being able to finance further investment as they no longer had these illiquid financial assets, helping to stimulate financial growth and activity.
In 2010, the level of completed asset purchases reached £200 billion, however when observed from the beginning of the policies in 2009, there is insignificant change at most of the maturity levels, this could be due to outside noise skewing the results (Joyce, et al., 2011). These asset purchases resulted in being roughly 14% of the nominal GDP level in the UK in 2010, three times its size before the financial crisis hit in 2008, this is a significant amount of the GDP which shows that the QE policies did influence the economy after the financial crisis of 2008 (Joyce, et al., 2011). Introducing quantitative easing policies to the UK from the financial crisis has been effective to the economy as through purchasing bonds there was a macroeconomic effect that was equal to a decrease in the short-term interest rate beginning at 1.5% to 3% (Gagnon, 2016). This will have made borrowing money from banks more favourable to businesses and potential investors as the rates will have been much lower, this will have increased the flow of money in the economy resulting in a boost in economic activity. The main evidence that QE has been successful within the UK is from their asset prices, there has been a basis point cut in the bank rate between 150 to 300 points which has met the aim of affecting output and inflation (Joyce, et al., 2011).
The other country to be analysed in this essay is the United States, the US Federal Reserve has been one of the highly active central banks since the financial crisis in 2007 in introducing unconventional policies (Fratzscher, et al., 2018). They began to introduce their QE policies in late 2008 by bringing the federal funds rate close to zero (Rogers, et al, 2014). The Federal Reserve also started to purchase a significant amount of mortgage backed securities from multiple financial institutions (Carlin and Soskice, 2015). This was initially limited to $500 billion but eventually increased to $1.25 trillion, these were introduced to be able to relieve pressure from mortgage interest rates (Stroebel and Taylor, 2009). Buying these bonds with long-term maturity dates allowed for the central bank to lower bond yields (Christensen and Rudebusch, 2012), however these policies have been criticised by foreign policymakers as doing this has caused an acceleration of capital flows to emerging markets through creating an excessive liquidity within the global economy (Fratzscher, et al. 2018). In a study conducted by Gagnon (2016), there was an estimation from Federal Reserve economists that the purchases made through quantitative easing has stimulated the economy almost identical to a 1% point cut in the federal funds rate, throughout the years this has also increased to 2.5% whilst also decreasing the unemployment rate by more than 1% in 2015 (Gagnon, 2016). One of the positives of the policies on the labour market in the US is that the unemployment rate fell faster than many economies had predicted and was within the 6.5% threshold by mid-2014 (Rogers, et al., 2014).
The impacts of quantitative easing were evident after policy announcements, with long maturity securities overnight index swap rates fell at the same rate as government yields, this contrasts with what happened in the UK with yield rates falling at a faster rate than the overnight swap rates (Christensen and Rudebusch, 2012). However, the same study found that overall from the QE policies there was relatively little impacts on the term premium but that quantitative easing reduced the expectations of short-term interest rates in the future at a higher rate (Christensen and Rudebusch, 2012). Another announcement that had significant impacts was in June 2013 with the end of the large scale asset purchase program (LSAP), for many people this brought forward the expected timeline before tighter monetary policy would be implemented, this resulted in an increased uncertainty in interest rates at a time when uncertainty was already high (Rogers, et al, 2014). Before the financial crisis in 2008 the Federal Funds rate was high at 2.89%, however through QE policies it has been able to reduce to 0.14%, money supply m1 also increased from $1.36 trillion to $1.792 trillion (Ashraf, et al., 2017). These figures show that quantitative easing policies in the US were effective as they were able to increase the money supply and stimulate economic activity within the country.
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I believe that the UK has been able to use QE policies more effectively, this is due to the UK being able to depress the yields of assets at a higher rate than the US relative to the size of their economies. One of the main differences between the US and the UK is the differences in the reactions to the expectations and premium components of long-term yields, the Federal Reserve was more forth coming in providing new monetary policies near the zero bound than the UK originally was (Christensen and Rudebusch, 2012). There is also significant evidence that the UK QE bond purchases have had a positive impact on economic growth and inflation, leading to less severe financial conditions (Christensen and Rudebusch, 2012). The policies implemented by the US, compared with Japan who were one of the first to implement QE, were less straightforward, as the Federal Reserve were trying to increase liquidity by increasing the lending windows they had in place (Ashraf, et al., 2017). However, there is also negative studies regarding quantitative easing as a monetary policy, with many stating that the policies may fail to create the levels of economic activity that are needed, this may not happen because the central banks will not be able to change the expectations about future policies (Ashraf, et al., 2017). Previous studies conducted by Tsuijmura and Tsujimura, have stated that there is insufficient evidence that quantitative easing boosts transactions within the economy due to reserve funds not being held as payment (Tsujimura and Tsujimura, 2018).
- Ashraf, A., Hassan, M.K. and Hippler, W. J. (2017) ‘Monetary Shocks, Policy Tools and Financial Firm Stock Returns: Evidence from the 2008 US Quantitative Easing’, Singapore Economic Review, 62(1), pp. 27-56.
- Carlin, W. and Soskice, D. (2015). Macroeconomics. Oxford: Oxford University Press.
- Christensen, J. H. E. and Rudebusch, G. D. (2012) ‘The Response of Interest Rates to US and UK Quantitative Easing’ Economic Journal, 122(564), pp. F385-F414
- Fratzscher, M., Lo Duca, M. and Straub, R. (2018) ‘On the International Spillovers of US Quantitative Easing’, Economic Journal, 128(608), pp. 330-377.
- Gagnon, J.E., 2016. Quantitative easing: An underappreciated success. PIIE Policy Brief, 16.
- Joyce, M., Tong, M. & Woods, R. 2011, "The United Kingdom's quantitative easing policy: design, operation and impact", Bank of England.Quarterly Bulletin, vol. 51, no. 3, pp. 200-212.
- Joyce, Michael, Ana Lasaosa, Ibrahim Stevens, and Matthew Tong. (2011),’ The Financial Market Impact of Quantitative Easing in the United Kingdom.’ International Journal of Central Banking 7 (3)
- Kapetanios, G., Mumtaz, H., Stevens, I. and Theodoridis, K., 2012. Assessing the economy‐wide effects of quantitative easing. The Economic Journal, 122(564), pp.F316-F347.
- Rogers, J.H., Scotti, C. and Wright, J.H. (2014) ‘Evaluating asset-market effects of unconventional monetary policy: a multi-country review’, Economic Policy, 29(80), pp. 749-799.
- Stroebel, J.C. and Taylor, J.B., 2009. Estimated impact of the Fed's mortgage-backed securities purchase program (No. w15626). National Bureau of Economic Research.
- Tsujimura, K. and Tsujimura, M. (2018) ‘A flow of funds analysis of the US quantitative easing’, Economic Systems Research, 30(2), pp. 137-177.
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