Is Quantitative Easing as Practiced by the Bank of England in Response to the Financial Crisis Ineffective?

2021-08-25 10:56:30
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Introduction

According to Joyce, Tong & Woods (2011), Quantitative Easing is a monetary policy that is applied by central banks in most parts of the world to increase the money supply in the countrys economy. This policy is only exploited when the interest rates either the bank and interbank is zero or close to zero (Hamilton & Wu, 2012). The central banks achieve quantitative easing by crediting its account with monies created out of nothing and then use the monies to buy financial assets such as corporate bonds, and government bonds. This process allows the banks to multiply the monies through lending which in turn helps in stimulating the countrys economy. Most governments choose this policy in a manner that is right so that it does not spiral inflation out of control. The major aim of this policy is to reach an economic point that is not too cold or hot, that is referred as a Goldilocks economy. This report, therefore, aims at presenting arguments that show that quantitative easing was ineffective in controlling the financial crisis in England.

Theoretical Frameworks on Quantitative Easing

In theory according to (Balatti et al., 2016) using printed monies out of nowhere on government bonds in order to increase their prices is likely to shrink the yields of those bonds. When the yields of such assets fall, it leads to a decrease in the borrowing rates for households and businesses, which further increases their investment, spending, and incomes. Consequently, higher prices for other assets and bonds create a better life for people because it gives them enough sources of income and this, in turn, increase their spending. On the other hand, when the central bank makes money available for pension and premiums, it encourages those institutions to lend more to businesses and individuals. This, in the long run, encourages the individuals and businesses to invest and spend more.

When the central banks get involved with the debt market by backing businesses up by raising capital for them through corporate bonds, then they can invest this money in the economy and their companies. This extra money that circulates in a countrys economy is then deposited in commercial banks, which increases the funds available for the banks to finance new business and individual loans and thus spending in the economy increases. According to Ellis (2009) this policy should create more jobs, increase a countrys GDP and increase business activities due to the high demand for investment and spending. However, the question is whether the theory of quantitative easing is always successful in real life practice.

Quantitative Easing in the UK

The financial crisis in the UK during the 2008 recession was severe in that it posed a threat to the economy of the country. In this respect, the Bank of England adopted the quantitative easing policy that led to the printing of 375bn to kindle spending so as to end the recession. The only way more money could be injected into the countrys economy was by involving banks that created more loans for lending and investments (Baumester & Benati, 2010). However, in the year 2009, the UK banks were hesitant to adopt this program because of the stigma and uncertainties that surrounded the repayments of the already existing loans. According to Joyce, Tong & Woods (2011) this how the program on quantitative easing began in the UK. The central bank printed an estimated 375bn which would be cover 6,000 for every citizen in the United Kingdom (Joyce, Tong & Woods, 2011). The government then injected this money into the financial markets instead of investing the money into the economy. This, in turn, this caused the rise of share prices by up to 20% (Joyce et al., 2012). The reason behind this action was that by flooding the markets, the central bank thought that the wealthy people would benefit more from the increasing share prices, and then they would invest this extra money in the real economy thus creating wealth. Although this was the case, unfortunately for the United Kingdom, half of the countrys stock markets are owned by the richest. This program only benefited the 5% of the rich UK citizens, while the others saw a slight benefit. According to Ellis (2009), the household income rose by approximately 128,000, and instead of the people investing this money into the economy, they bought more shares at the stock exchange markets so as to benefit only themselves and to get richer.

While the central bank of England continued with the quantitative easing program, the government ran out of money nonetheless, this is from the year 2010 (Mamaysky, 2014). This affected government projects that had been initiated such as building schools, roads, flood projects and other job-creating schemes which were all scrapped. Instead of the printed monies creating new jobs, the beneficiaries of it flooded it in the equity markets where it was trapped. This also led to the loss of employment for some construction workers, but the irony is that it would have cost the government 1bn or less to ensure there were zero job losses. According to (Balatti et al., 2016) if the central bank gave the government 10bn of the money printed other than inflating share prices at the equity markets, then the recession the recession would have ended sooner, and the government could also have created over 280,000 jobs. Practically, investing 1 in the quantitative easing program the economy would likely grow by 8% (Neely, 2012). This is to mean that each 1 put into the real economy would see it grow by 2.80 (Neely, 2012). The perception according to Kozicki, Santor & Suchanek (2011) is that as at 2014, the balance sheet of the central bank of England was below 25% when compared to the UKs GDP.

The sterling was also affected negatively by the decrease in the gilt yield, leading to its depreciation. Once the announcement of the quantitative easing program was made, the sterling pound was affected badly in that it depreciated by 4% (Joyce et al., 2010). However, according to Bridges & Thomas (2012), the largest fall of the sterling pound occurred when the central bank made public the inflation report which was not acknowledged in the quantitative easing news. From the graph below if a UIP was performed using the 3yr OIS rate, that is in order to isolate the policy news component, and then the implied reduction in the exchange rate would only have been 0.5% which means that the initial reaction of the sterling was marginally greater than the expected fall (Peersman, 2011).

Source: Joyce, M., Lasaosa, A., Stevens, I. and Tong, M. (2010) The Financial Market Impact of Quantitative Easing, Bank of England Working Paper No. 393.

However, a portfolio rebalancing would change the effects of QE on the sterling although it may take longer to show effects than a two-day window could allow (Swanson, 2011). For example, over the period between February 2009 and May 2010, the pound appreciated by approximately 1%. The obvious explanation according to Joyce et al. (2010) is that quantitative easing did not change the views of investors on its prospects which saw earlier falls on the sterling and other policies being copied around the world.

Conclusion

Eventually, even after the quantitative easing program, the UK got stuck in rather low inflation trap, and the monetary policies in place were no longer helping. With the interest rates nearing 0% and a monetary policy that was loose for quite some time then it is clear that the Central Bank of England had played all available cards right (Mamaysky, 2014). Reducing the quantitative easing would only lead to a decrease in spending, inflation, and growth, while increasing the quantitative easing to on the other hand lead to an increase in debt, affect inflation marginally and increase the waste of money. Consequently, keeping the quantitative easing at the current levels would not make the inflation rates reach 2% which is the central banks target rate (Krishnamurthy & Vissing- Jorgensen, 2011).

Source: Bloomberg

Also as seen in the table above increasing the rates will only cut growth and spending and keeping the same rates will not affect the inflation levels and current spending that is already viewed by the central bank as low. Cutting these levels will also not be possible unless the bank reduces the interest rates to negative territories. According to Hausken & Ncube (2013), this would also not be effective as it was tested and tried in Japan and did not fair on well. Currently, the Japanese balance sheet is almost 90% of the countrys overall economy. The inflation rate has not risen and the yield of yen has dropped (Hausken & Ncube, 2013).

References

Balatti, M., Brooks, C., Clements, M.P. & Kappou, K. (2016)Did Quantitative Easing Only Inflate Stock Prices? Macroeconomic Evidence from the US and UK,Henley Business School - ICMA Centre working paper.

Baumeister, C. & Benati, L. (2010). Unconventional monetary policy and the great recession - Estimating the impact of a compression in the yield spread at the zero lower bound, Working Paper Series No. 1258, European Central Bank.

Bridges, J. & Thomas, R. (2012). The impact of QE on the UK economy some supportive monetarist arithmetic, Bank of England Working Paper No. 442.

Ellis, C. (2009)What Impact Have the Bank of England's Asset Purchases Had, The Lantern Research Paper.

Hamilton, J.D. & Wu, J.C. (2012). The effectiveness of alternative monetary policy tools in a zero lower bound environment, Journal of Money, Credit and Banking, vol. 44(Supplement), pp. 346.

Hausken, K., & Ncube, M. (2013). Quantitative Easing and its Impact in the US, Japan, the UK and Europe.

Joyce, M., Lasaosa, A., Stevens, I. & Tong, M. (2010) The Financial Market Impact of Quantitative Easing, Bank of England Working Paper No. 393.

Joyce, M., Miles, D., Scott, A., & Vayanos, D. (2012). Quantitative easing and unconventional monetary policyan introduction. The Economic Journal, 122(564).

Joyce, M., Tong, M. & Woods, R. (2011) The United Kingdoms Quantitative Easing Policy: Design, Operation and Impact, Bank of England Quarterly Bulletin 51(3), pp. 200-212.

Kozicki, S., Santor, E. & Suchanek, E. (2011). Central bank balance sheets and long-term forward rates, in (Jagjit.S. Chadha and S. Holly, eds.), Interest Rates, Prices and Liquidity - Lessons from the Financial Crisis, pp. 195221, Cambridge: Cambridge University Press.Krishnamurthy, A. & Vissing-Jorgensen, A. (2011). The effects of quantitative easing on interest rates: channels and implications for policy, Brookings Papers on Economic Activity, vol. 2, pp. 21587.

Mamaysky, H. (2014) The Time Horizon of Price Responses to Quantitative Easing, Columbia University - Columbia Business School working paper.

Neely, C. (2012). The large-scale asset purchases had large international effects, Federal Reserve Bank of St. Louis Working Paper No. 2010-018A.

Peersman, G. (2011). The macroeconomic effects of unconventional monetary policy in the euro area, ECB Working Paper Series No. 1397.

Swanson, E.T. (2011). Lets twist again: a high-frequency event-study analysis of Operation Twist and its implications for QE2, Brookings Papers on Economic Activity, Spring 2011, pp. 151207.

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