A desperate measure for desperate times, but does it work?
By Romain Fournier
Since the beginning of the financial crisis in 2008, Quantitative Easing (QE) has been part of the so-called unconventional measures taken by the central banks of the US, Japan and UK.
The aim was to refinance troubled banks by buying their toxic assets, whose value has strongly depreciated during the crisis.
The Fed is currently on its fourth round of QE since 2008, the latter reaching approximately $40 billion per month, providing liquidity to US banks in a bid to revitalise the economy. The Bank of England has so far committed a total of £375 billion to QE.
This practice is often considered as a last resort option in desperate times, but does it work?
Great means, little results
If you look at US statistics, growth isn’t particularly impressive, but unemployment is relatively low compared to other developed countries. However, it raises questions about the sacrifices that have been made to achieve these relatively weak results.
Indeed, the resulting weakness of the dollar heavily impacts the country’s trade balance, increasing the cost of imported goods, thus raising the national debt, which is already huge.
Ultimately, it is a policy of great means, but with little results. Only the falling dollar, pound or yen will positively affect exports. And it isn’t without dangers.
Dangers of QE
While inflation still isn’t threatening the US economy, we should be wary of stock market bubbles due to the influx of capital available. And let’s not forget that the depreciation of the dollar also lowers the competitiveness of countries that do not trade in this currency.
The main risk of this practice is to create a strong inflation when growth returns and to create havoc on markets when exiting QE. City AM reported this week that a failure by the US Federal Reserve to engineer a smooth exit from its quantitative easing programme could wipe 40 per cent off global equity prices. Research from Fathom Consulting also warns of a knock-on effect on central London prices.
History shows we have reasons to be fearful. Japan has experience QE before the US and its effects where far from conclusive, increasing its balance sheet by 21 per cent of GDP at the end of 2007 to 24.5 per cent at the end of October 2010, according to figures from newspaper Les Echos.
Quantitative Easing is also responsible for the hyperinflation we can see in Zimbabwe today, which was also witnessed in Weimar Germany, Hungary in 1946 and Chile in 1971. This is what happens in most countries where central banks try to finance the budget deficit.
The real economy
We can only agree with the words of Richard Murphy, an economist and accountant who runs Tax Research UK, and who told the Guardian: “QE doesn’t work. It pumps lots of money into the banks but they don’t lend it on. Almost certainly it will be used for them to speculate overseas. Will any move into the UK economy? No. It will improve banks’ liquidity, not the UK economy. Government needs to put money into the real economy.”
And it seems that Bank of England’s new governor Mark Carney may have reached the same conclusion, with the Bank of England announcing last week its decision to stop QE.