Lets take a look at how monetary stimulus works and also, how effective it is, the benefits and also the risks of QE. Let's start, with the normal way a Central Bank regulates economic activity:
The Economy and Interest Rates
Central banks normally use interest rates to regulate economic activity and control inflation. If the central bank lowers interest rates, it encourages consumers and businesses, to spend money rather than save it. What happens when interest rates are so low, cutting them will have no effect on the economy?
Quantitative easing was first introduced in Japan in 2001 to try and halt the deflationary recession the country was in and since 2001 many Central Banks, have decided that the way forward so wqhat actually is the purpose of quantitative easing?. The aim is to simply increase the amount of money in the economy to try and kick start growth but how do they do this and how effective is it?
Quantitative Easing Explained
The answer is monetary stimulus where the Central bank pumps money into the economy and this is known as quantitative easing (QE). The way this is done is by buying assets, usually government bonds ( but it can be other assets) by expanding the money supply. The institutions selling bonds are normally banks and large financial institutions, such as pension or insurance companies.
These financial institutions, t have this "extra" money to play with which in theory increases the supply of money in the economy. Money is not actually printed, its just done electronically with the flick of a switch but the balance sheet of the central bank is expanded so its effectively the same effect as printing money.
The effect of the government expanding the balance sheet means - they have boosted cash deposits to encourage commercial institutions such as banks, who then in theory should be keener to lend to businesses and consumers, who can stimulate economic activity, with the extra cash they have.
In addition, buying government bonds means there price will rise which leads to a fall in long term interest rates. Lower interest rates in theory should of course stimulate more activity in the wider economy but does it work and what are the risks? Let's take a look in more detail at the effect of monetary stimulus since 2001.
Does Quantitative Easing Work and What are the Risks of QE?
Lets take a look at the risks of QE:
A central bank can lose money doing this and the money lost, will be paid by tax payers either in - higher taxation or by the central bank creating more money and risking inflation or hyper inflation further down the road.
If you create to much money, you will not only destroy the currencies value - you will also reduce confidence in the economy and policy making.
Of course a major risk is Inflation or even hyperinflation and if you want to know how disastrous printing money can be, just look at what happened to Germany in the 1930s.
So the risks of QE and monetary stimulus are high but is it worth the risk? in the short term there is a case put by economists that it can boost economic growth but have we seen any benefits of QE in the countries which have tried it?
The answer is no and unless its stopped, it will lead to disaster.
Reckless lending by banks in many countries has seen them pile up huge bad debts so what do Central Banks do? They reward them and boost there balance sheets! Of course these institutions are reluctant to lend and keep the it on there books, as a provision against bad debts which they have run up and to boost there balance sheets. Why lend when interest rates are so low? On the other side of the equation, consumers and businesses, simply cannot borrow money because - the banks won't lend to them. There is also another problem which is - consumers and businesses, both have big debts which they accumulated in the years of reckless lending and are so in debt, they have little free cash to spend and can't borrow either.
The evidence quantitative easing doesn't work can be seen in - Japan, the USA and the UK. In these countries, trillions of dollars of new money has NOT kick started growth at all. The idea of injecting money, into these economies has not created growth in the economy and has simply swelled banks balance sheerts and it's leading the global economy down the road to disaster.
The banking system was out of control for years and now, everyone is paying the price for there reckless behaviour. Now we also have the ludicrous scenario of - banks being rewarded for creating the mess of debt which we have in the global economy! If Governments were sensible, they would force banks to lend or inject, the money directly into the economy in terms of work projects, where ordinary people and businesses would benefit. The whole way banks operate should be changed and regulation, should be tightened. In addition, Governments should be helping the people, rather than greedy banks who have created a mess which will burden future generations, with the cost of their mistakes .
Most economists would agree, QE can only work in the short term and the longer it goes on, the bigger the problems are for the economy become, in terms of a recovery from recession. It's been tried since 2001 which is now over a decade and it clearly hasn't worked. It's now time to change policy before its to late. The pros of QE are none that I can see and the cons, are there for everyone to see which we have just disccussed - it simply doesn't work and can anyone tell me a benefit of continuing with it? There are no benefits - just the risk of global meltdown.