This article appeared originally in Gulf News: link to original article
Quantitative easing (QE) has almost been forgotten even though it is still being used to spur inflation, in Japan for instance. A few media outlets refer to this as throwing cash from helicopters. Is it?
Well, at least, that’s how it seems to be even if that isn’t the case. The article will explain the difference and what could work to achieve inflation targets.
So the central bank cannot meet its inflation target. Inflation is the result of too much money being circulated in the economy, or the result of suppliers increasing the prices for their products and services. Anyway, the aim of QE is to have more money going around in the economy.
This is done by the central bank “printing money” that it uses to buy government bonds from banks. Then, banks use the extra cash to finance market activities. And that should work, right?
Here is the thing. First, banks finance market activities by giving out loans. Taking on debt, which results in less disposable income and less spending, means that the economy’s money multiplier — the rate at which it changes hands — will not go high enough for the economy to heat up inflation.
And so the main goal of starting a QE programme — increasing money circulation in the economy — will not be achieved. Secondly, the banks themselves may be reluctant to lend the money out, especially if reserve ratios are not lowered. That could be attributed to the fear of economic recovery or perhaps economic future uncertainty.
The third reason follows the same logic of the second one except that it is for individuals who would rather stash the cash or save their money instead of spending it.
Is QE working? It did work in the US to a certain extent because the US is an unique case — having the world’s most dominant currency and being its sole guardian. The EU? Having a common currency for a wide range of economies would be a main setback for its QE.
Japan? The programme is still ongoing and there seems to be light at the end of tunnel especially after postponing the hike in consumption tax as well as introducing negative rates for bank deposits. There are also talks that the Bank of Japan will expand its QE programme further.
Will it work at the end for Japan’s economy to achieve the 2 per cent inflation rate that it has been wanting to attain for decades now? We shall see.
So we can’t say now that QE is like throwing cash from helicopters, that is, handing cash to individuals. It has been debated lately whether or not issuing tax rebates would be better for individuals, or just depositing cash into their bank accounts.
This may still not work because of the third reason mentioned earlier. Instead, it may be worthwhile to conduct a cost-benefit analysis of bailing individuals out. In other words, paying their debts so they could have a fresh start — such as student loans in the US.
There are no guarantees though that this will work unless a mechanism is put in place to ensure that people will not start saving all of the extra cash they have been getting since being bailed out. Such a mechanism should also include negative interest rates on bank deposits and the termination of big currency notes.
The latter is to deter individuals from storing cash at homes like is happening in Japan and Argentina. Will that be sufficient?
A single action will not be, but perhaps a combination of most if not all of what was mentioned earlier. Tax rebates, bailing individuals out, negative deposit rates, lower reserve ratios and the removal of big money notes could all be done to encourage inflation if the actions were taken simultaneously.
The last thought that I want to leave you with is: At what debt level can QE still work for an economy?