Q is for quantitative easing

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.


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