[3] Quantitative Easing Flashcards
Policy Responses to the financial Crisis:
In the first instance, emergency ____ provision which is not the same as _ _
___ changes followed, geared towards addressing perceived shortcomings associated with bank capital requirements and to try ‘___ ___’ the sector.
In the first instance, emergency liquidity provision which is not the same as QE
Regulatory changes followed, geared towards addressing perceived
shortcomings associated with bank capital requirements to ‘shock proof’ the sector
Macroeconomic consequences of the crisis
[3 Major]
Largest GDP reversals since the Great Depression: UK real GDP at the start of 2010 more than 6% less than at the end of 2008. These figures are substantial, and similar to those experienced by other countries.
Countries such as the UK and US witnessed particularly weak recoveries from the depths of the recession - after positive growth in 2009/10 the UK growth rate reverted to approximately zero before
(finally) recovering.
Personal incomes were forecast by some economists as being unlikely to return to their pre-recession levels until the middle of the 2010s. Means that one effect of the crisis is to make us an average poorer.
Macro Policy Environment [5]
What was cut? By how many Basis Points? what is Typical cut?
What were rates in UK US Europe?
x2 records of these cuts?
What rose sharply and why?
What was resorted to and by who?
Dramatic interest rate cuts: in November 2008 the Bank of England reduced its policy rate by 150 basis points. This is a huge change, given that typical policy changes are 25 basis points.
By 2009 central bank interest rates at 0.5% in the UK, 0-0.25% in the US and 1% in the Euro area.
Policymakers in the US, UK, ECB set to keep rates at record lows for record periods, joining BoJ.
Fiscal deficits and sovereign debts have rose sharply as the world economy slowed and automatic stabilisers operated to cushion demand.
Central banks resorted to using quantitative easing (QE)
What was the size of the US and UK’s QE package and % of GDP?
Main Objective of Europe, UK, BoJ package
US: $3.7tr 22.7%
UK: £375bn , 22%
Price stability (inflation 2%)
The ___ __ ___ for nominal interest rates limits the extent to which conventional __ __ can be used to stimulate demand in recessions.
Why?
Further, the use of fiscal policy to support demand was effectively ___ as governments cut ___ to stabilise debt and tackle ___ fears.
Quantitative easing is an example of ___ monetary policy that can be used when other measures are __ available
zero lower bound (ZLB), monetary policy
Once rates are at zero, the government can no longer reduce rates any further to stimulate demand.
reversed
deficits
solvency
unconventional
not
WHAT IS QE:
___ __ creates electronic accounts credited with ___ cash balance (addition to the monetary __), and uses these accounts to __ ___from financial institutions.
This has the effect of ____ private sector (e.g. commercial bank) ___ ___.
Modern equivalent of ___ ___, albeit no physical money is actually printed, but, the policy is eventually ___, meaning that it is not the same as ___ ___
Significantly, the central bank ___ ___ in the process, so QE is not the same as merely handing out cash.
QE was adopted by the __ __ __ in the early 2000s, and the Bank of England and US Federal Reserve in ___.
Central bank creates electronic accounts credited with new cash balance (addition to the monetary base), and uses these accounts to purchase assets from Önancial institutions.
This has the e§ect of increasing private sector (e.g. commercial bank) cash balances.
Modern equivalent of printing money, albeit no physical money is actually printed, but, the policy is eventually unwound, meaning that it is not the same as monetizing debt.
SigniÖcantly, the central bank acquires assets in the process, so QE is not the same as merely handing out cash.
QE was adopted by the Bank of Japan in the early 2000s, and the Bank of England and US Federal Reserve in 2009.
What is unconventional about QE?
First, asset purchases are financed from __ __ cash, so the overall balance sheet of the central bank __.
Conventional OMOs (_ _ _) involve central banks financing asset purchases through ___ their holdings of some other ___ (medium-term bills, foreign exchange), i.e. the composition of central bank assets shifts towards the less ___ end of the spectrum (and __ ___ become relatively more liquid) but total assets are __.
Purchasing bonds is always a __ option for central banks because they may__ _ before they are sold, but QE is more risky because it entails __ __ expansion
First, asset purchases are financed from newly created cash, so the overall balance sheet of the central bank expands.
Conventional OMOs (open market operations) involve central banks financing asset purchases through reducing their holdings of some other asset (medium-term bills, foreign exchange etc.), i.e. the composition of central bank assets shifts towards the less liquid end of the spectrum (and private assets become relatively more liquid) but total assets are unchanged.
Purchasing bonds is always a risky option for central banks because they may lose value before they are sold, but QE is more risky because it entails balance sheet expansion
To cover this risk, the Treasury has agreed to __ losses on asset dealings and therefore __ __ is required for QE.
The Banks ability to make asset purchases therefore requires Treasury ___.
Why? The Treasury ___ the Bank against losses arising from the Asset Purchasing Facility and thus exposes the ___ to risk.
The consequence is that the use of the QE instrument is effectively at the ___ of government and this ___ the operational ____ given to the Bank in 1997.
Without the indemnity, however, the Bank could conceivably be exposed to ___ ___ that it would then have to ___ by ___ the size of its balance sheet and the income earned from its assets.
In these circumstances, it could no longer claim to be wholly committed to __ ___ as its policy objective.
To cover this risk, the Treasury has agreed to underwrite and losses on asset dealings and therefore Parliamentary approval is required for QE.
The Bankís ability to make asset purchases therefore requires Treasury approval.
Why? The Treasury indemnifies the Bank against losses arising from the Asset Purchasing Facility and thus exposes the taxpayer to risk.
The consequence is that the use of the QE instrument is effectively at the discretion of government and this undermines the operational independence given to the Bank in 1997.
Without the indemnity, however, the Bank could conceivably be exposed to capital losses that it would then have to offset by varying the size of its balance sheet and the income earned from its assets.
In these circumstances, it could no longer claim to be wholly committed to price stability as its policy objective.
Asset purchases operate to a ____ target, e.g., £ 375 billion in UK, whereas conventional OMOs would operate to a __target, e.g. purchase bonds until the __ ___ is suficient to lower __ __ to 4%.
QE used whilst interest rates at the _ _ _, so monetary policy cannot be set as a __ target. Since it is specified in quantity terms, there is a _-___
decision when assets mature.
The US Federal Reserve purchased a very broad range of assets, specifically, __ ___s and securities [as well as government bonds] (riskier than the UK)
This is in contrast, traditional OMOs focus on ___ ___
Asset purchases operate to a quantitative target, e.g., £ 375 billion in UK, whereas conventional OMOs would operate to a price target, e.g. purchase bonds until the money supply is su¢ cient to lower interest rates to 4%.
QE used whilst interest rates at the ZLB, so monetary policy cannot be set as a price target. Since it is speciÖed in quantity terms, there is a re-investment
decision when assets mature.
The US Federal Reserve purchased a very broad range of assets, specifically, corporate bonds and securities as well as government bonds were purchased (riskier than the UK)
This is in contrast, traditional OMOs focus on government bonds
QE was originally intended to increase spending by encouraging more__ ___ __.
QE was intended to increase the___ of ___ owners (___ effects), encouraging them to spend more.
private sector borrowing
QE was intended to increase the wealth of asset owners (wealth effects), encouraging them to spend more.
QE leaves private investors long in __ that yields a low __. To generate returns, firms rebalance portfolios towards assets such as ___ bonds and __issued by firms.
These private assets are central elements of the ___ banking system (i.e. the means by which large firms obtain ___ without using banks).
The interest rate on a corporate bond is the ___ divided by the price, while that on equity is the __ divided by the price
A key point is that these interest rates are ___ even when the policy interest rate of the central bank is at or close to __ (e.g. due to the risk on lending to these firms versus depositing cash at the ___ ___)
Portfolio ___ from QE thus drives up ___ for corporate bonds and equities, depressing the__ ___ paid in the ___ banking sector
QE leaves private investors long in cash that yields a low return. To generate returns, firms rebalance portfolios towards assets such as corporate bonds and equity issued by Örms.
These private assets are central elements of the shadow banking system (i.e. the means by which large Örms obtain Önance without using banks).
The interest rate on a corporate bond is the coupon paid divided by the price, while that on equity is the dividend paid divided by the price
A key point is that these interest rates are positive even when the policy interest rate of the central bank is at or close to zero (e.g. due to the risk on lending to these Örms versus depositing cash at the central bank)
Portfolio rebalancing from QE thus drives up prices for corporate bonds and equities, depressing the interest rates paid in the shadow banking sector
Facing lower ___ costs in the shadow banking sector from ___ ____, corporations are better able to engage in hiring, investment etc., which boosts ___.
However, note two caveats:
- Corporations may use lower Önancing costs to boost ___ and their capital ___, so rises in expenditure may be ___
- Small firms and households will not beneÖt ___, only ___ if large corporations choose to spend the gains
Facing lower financing costs in the shadow banking sector from portfolio rebalancing, corporations are better able to engage in hiring, investment etc., which boosts aggregate demand.
However, note two caveats:
corporations may use lower Önancing costs to boost proftability and their capital ratios, so rises in expenditure may be delayed
Small firms and households will not beneÖt directly, only indirectly if large corporations choose to spend the gains from cheaper Önance
QE can be interpreted as a way of committing to very ___ monetary conditions for an ___ period.
QE raises the __ and ultimately the __ money supply so that there is an excess supply of ___ in the money markets
Given limits to the speed at which liquidity can be drained from the markets, this will keep interest rates __ and ináation ___ even after economic recovery is entrenched
In this way QE helps make the optimal policy look credible in the eyes of the__ ___ and increases its e§ectiveness
QE can be interpreted as a way of committing to very lax monetary conditions for an extended period.
QE raises the narrow and ultimately the broad money supply so that there is an excess supply of liquidity in the money markets
Given limits to the speed at which liquidity can be drained from the markets, this will keep interest rates low and ináation high even after economic recovery is entrenched
In this way QE helps make the optimal policy look credible in the eyes of the private sector and increases its e§ectiveness
Explain how by adopting QE, one may argue that the BoE is arguably no longer committed to price stability as its policy objective?
The optimal central bank policy is to promise to deliver low interest rates and high ináation for an extended period, as this will force down current real long-term interest rates, which matter most in
stimulating expenditure.
But such a policy is not time-consistent: if the Bank really cares about ináation, when future growth and ináation start to rise in response to the low interest rates, policymakers will seek to return the short-term interest rate to normal levels, in order to avoid missing the ináation target.
The private sector realises this and therefore might not respond to any promises to keep interest rates low.
Explain the Monetary transmission mechanism under QE
Bank of England Asset Purchases
↓ ↓ Inc. asset prices Inc Money in Econ (Dec. yields)
↓ ↓ ↓
Inc Bank Inc cost of Inc Total
Lending Borrowing Wealth
↓
inc spending and income
↓
inflation at 2%
