Q is for quantitative easing

June 21st, 2014 at 4:00 pm by David Farrar

The hits Q:

Those who read the business pages may have come across the term (QE), an apparently magical potent for reviving debt-ridden economies; almost like a shot of adrenaline in the arm of a dying patient.

Prior to QE, the orthodox medicine for monetary authorities to use to stimulate the economy was to lower interest rates on some form of official debt, such as the interest rate the central bank pays on overnight deposits, and/or increase liquidity in the banking system by buying back government term debt. The latter technique is called an open-market operation (OMO). In addition to its liquidity effect it will raise prices of term debt, lowering its yield. By either measure, the authorities can hope to make private credit cheaper, stimulating investment in businesses, housing and consumer durables.

QE’s most striking point of distinction from an OMO arises when it involves buying back privately-issued paper instead of government paper. (But note that some define QE to include buying longer-term government paper than is usually bought in the US in an OMO.)

Why would the authorities buy private paper, particularly paper of dubious value held by injudicious private banks, when there is no shortage of medium- and long-term government debt to buy? Why indeed.

In deciding what private securities to buy, government is favouring some issuers (eg those issuing mortgage-backed bonds) and some holders (eg banks) at the expense of others. It is also shifting private risks to taxpayers. The government could easily pay too much for those assets since its buying power is likely to bid up their prices. An unwanted effect might be to make imprudent banks stronger and taxpayers weaker (via government) through hidden subsidies.

Moreover, what happens when the monetary authorities subsequently decide that the additional liquidity needs to be reduced? Reversing the process by selling the accumulated private paper in large amounts could undesirably disrupt the primary issuance market (eg for mortgage lending).

One argument in the US in favour of QE (focused on buying private mortgage-related debt) is that the US suffered such disruption to this market in the global financial crash that special assistance is desirable to ‘unfreeze’ it. This argument may be more political than economic.

In conclusion, heavy recourse to QE is a sign of desperation – a bit like reaching for unproven fringe medical remedies in the belief that proven mainstream treatments can do no more.

That’s a very good academic summary of the idiocy that is quantitative easing. I prefer the John Clarke version.

Superb.

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19 Responses to “Q is for quantitative easing”

  1. YesWeDid (1,044 comments) says:

    Kind of misses the point.

    A country will only use QE as a desperate last measure to stimulate its economy after interest rates have basically been wound back to zero. One of the major effects is a reduction in the exchange rate. The US, UK and Japan have used QE and that is part of the reason our dollar has appreciated compared to theirs.

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  2. Gulag1917 (814 comments) says:

    Rearranging deck chairs on the Titanic, the world economy is stuffed.

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  3. Bob (496 comments) says:

    Correct me if I am wrong. Quantitative easing is good old fashioned printing money. It devalues the currency hitting savers. It works for a while then catches up leaving everybody poorer except those who use devalued money to pay off investment debt. That is how a few millionaires have been made while old ladies living off savings are poorer.

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  4. gravedodger (1,528 comments) says:

    John Clarke is one of the few who can explain it, sheesh!!
    But then he is a graduate of the Bruce Bayliss school of economics.

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  5. Johnboy (15,586 comments) says:

    He’s a SCOB too gravedodger! :)

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  6. thor42 (971 comments) says:

    “They can create a bit of a vacuum while reaching cruising height…” :)

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  7. Steve (North Shore) (4,522 comments) says:

    Bob, you are wrong; it is not old fashioned, it is current Green/Labour Policy, nothing old about it :)

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  8. Steve (North Shore) (4,522 comments) says:

    gravedodger,
    Bruce Bayliss – that’s B – R – U – C – E. 1975 was a long time ago

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  9. wat dabney (3,721 comments) says:

    I agree that the article misses the point. QE, as envisaged, is intended purely to prevent a collapse of the money supply, which is what turned a recession into the Great Depression. An essential measure, then.

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  10. mjw (352 comments) says:

    QE is not necessarily a bad investment by Government – as a counter-cyclical investor of last resort, Governments often clean up after financing a bail out. Also, if interest rates are already at zero, QE may be necessary to maintain a Keynesian stimulus.

    Funny how all the central bankers are Keynesians. I suppose they can’t help thinking that way, as it is a major part of the justification of their job. I often hanker after a freer market in financial services, with mandatory deposit insurance, but the private banks have become so powerful, and so expert at manipulating the politicians, that seems an impossible dream.

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  11. All_on_Red (1,489 comments) says:

    QE is wrong because it’s about stimulating demand. The true way to grow an economy is to stimulate production.
    Demand follows production, not the other way around.
    I would suggest that economies have only succeeded after QE because entrepreneurs finally won through. For example in the US the breakthrough in fracking technology is probably going to be the counterweight which overcome the madness which QE is and allows production to win through and get the economy going again. Production of shale gas and oil creates jobs, creates low energy cost and off the economy goes.
    The Greens are fuckwits. What does an ex Nurse with PHD on a failed political party know.

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  12. OneTrack (2,818 comments) says:

    YesWeDid – “A country will only use QE as a desperate last measure to stimulate its economy after interest rates have basically been wound back to zero.”

    Except NZ has a relatively ok economy, and the Greens want to print money anyway to “pay” for their idiotic policies.

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  13. slijmbal (1,223 comments) says:

    I’m with Bob and will go one step further – QE will lead to significant devaluation and/or inflation.

    The US has a recent habit of putting off the effects of market cycles. It’s rather Canute like as such delays tend to make the corresponding market drivers being held back much stronger. There’s a reason the GFC was the worst since the Recession.

    A government can mollify the effects of the ups and downs of markets but it cannot truly control them.

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  14. mjw (352 comments) says:

    OneTrack – yes the Greens policy makes no sense at all.

    Slijmbal – the other factor is that the US wanted inflation to reduce the real value of its debt to the Chinese. The Chinese hated that, but couldn’t do anything about it.

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  15. Crusader (295 comments) says:

    QE is like pissing in your pants to stay warm. Doesn’t work for very long.

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  16. CharlieBrown (925 comments) says:

    QE is just another socialist invention to fix problems made worse by socialism. Like just about every socialist initiative it will come back to bite us. It is a mechanism to make everyone just a little bit more poorer rather than letting those that made bad investments or incurred bad debt live with their mistakes – trickle down poverty.

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  17. seanmaitland (472 comments) says:

    @wat dabney “I agree that the article misses the point. QE, as envisaged, is intended purely to prevent a collapse of the money supply, which is what turned a recession into the Great Depression. An essential measure, then.”

    No, no, no – its purely about stimulating economic growth – nothing to do with preventing the monetary supply from collapsing.

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  18. tvb (4,255 comments) says:

    This practice is being done by the Bank of Japan, The Federal Reserve and the Bank of England. They are wanting to wind it down but are finding that difficult. Inflation does remain subdued in all three countries.

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  19. Paulus (2,565 comments) says:

    tvb

    That is why our dollar is high because of the socialist incompetence that took place over 10 years ago in the countries you name.
    It will take many years for them to come back to a balance if ever.
    New Zealand as a small economy has weathered similar effects following the Clark/Cullen socialist debacle.
    We are not out of the woods yet but by controlling spending and not kowtowing to the union demands we may yet survive.

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