Then, the influences of this policy, especially for banking industry will be addressed. In 2009, the Bank of England decided to implement the CEQ in UK as well. In this part, a brief comparison of consequences between US and UK will be addressed. The third part is relevant with Japan, which is the first country that applied CEQ policy in the world, to solve the asset bubble collapse in 2001. Finally, a brief comparison of US and Japan will be put forward and some summing-up will be argued in the conclusion. 1.
Introduction When the economy takes a downfall, the government wants the economy going again. They typically spend more money on the social project to flood the money to the market. Sometimes, it does not work, they will lower the interest rate of lending to encourage more people to borrow the money and stimulate economy. However, when the economy is hard to recover and the banks are experiencing insolvency, cannot make loans anymore, central bank and government seek to figure out another way to reverse the economy downturn.
Quantitative easing (CEQ) policy is unconventional monetary’ policy that central bank provides extra money to banks or interbrain market to achieve low and stable inflation and lower the long-term yield (Joyce, Lassos, Stevens& Tong 201 1 ). Alt usually realized by using non-existed money to arches government bonds and treasuries to directly inject the money and spur economic growth by encouraging banks to lend money. In recent years, some advanced economies like US, UK and Japan frequently adopt CEQ to increase the money and stimulate the economy.
The effectiveness is different between those countries. If the money supply increases too quickly, bad inflation will destabilize the economy further. The reason for doing CEQ policy in this project is to discuss the effectiveness of CEQ in different countries. The problem we are going to tackle is how this policy was processed and how hose follow-up impacts affect other economies. 2. CEQ Of US 2. 1 Background Global financial crisis The financial crisis of US that erupted in 2007-2008 had thrown economic around all over the world into the global economic recession.
The seed of the crisis was the lending boom of the bank due to the expansion of money base that peaked in mid-2007. The sub-prime mortgages were booming. Because of the economic turmoil, the house bubble began to collapse. And it followed by the breakdown of mortgage and securities products like COD and Mbps. The severe situation that banks had to deal with was the credit crunch. The Geiger one shows the total amount of loans issued recent years of US. There was a substantial decline of loan issued by banks during the period Of 2007-2008 (showed in figure 1).
Figure 1 Source: Fashion and Christine (2008), Bank lending during the financial crisis of 2008 During the September-November of 2008, lending was reduced by 27% compare with the prior three-month period and it was 68% lower than the peak of the credit boom of the period of March-May 2007 (Fashion and Christine 2008). The credit crunch led to the bank insolvency. Central banks began to realize policy rate decreasing and facilitate balance sheets expansion as soon as possible to support credit Of other banks after the collapse of Lehman Brothers.
Monetary Policy The Fed reserved responded the economic downturn rapidly in 2007. The Federal Reserve started CEQ policy in September 2007, the target for the federal funds rate was reduced by 50 basis points and its target for the federal funds rate was brought down by a cumulative 325 basis points by the spring of 2008 (Brenan 2012). During the crisis period, the interest rate almost has reached its limit, 0. 5%, as it was lowered by Fed Reserve through traditional monetary policy the traditional monetary policy and has a target ate for the federal funds rate of D. O to 0. 5 % (NATO 2009). However, the multiple cuts in the policy interest rate failed to stimulate the economic activities and the dysfunction of banking credit market was still serious. To provide more liquidity into the market, the US Federal Reserve announced the unconventional monetary policy intervention that purchase long-term government bonds to reduce long-term interest rates in order to spur economic activity. 2. 2 CEQ -CEQ Description The CEQ policy was used to increase the money base and stimulate the economy during the SGF. The table 1 shows the important announcement of Fed Reserve.
Table 1: Key Announcement of CEQ policy in US DATE Program event Brief description 1 1 /25/2008 CEQ FOMCL statement Lisps announced: Fed will purchase $100 billion in SSE debt and $500 billion in MBPS. 3/18/2009 L SAPS expanded: Fed will purchase $300 billion long-term Treasures and an additional $750 and $100 billion in MBPS and SSE debt, respectively. 8/1 2/2009 All purchase will finished by the end of 201 0: IQ 11/3/2010 CEQ CEQ announced: Fed will purchase $600 billion in Treasuries 6/22/201 1 CEQ finished: Treasury purchase will wrap up at the end of month, as scheduled; principal payments will continue to be reinvested. /13/2012 CEQ CEQ announced: The Fed will purchase $40 billion of MBPS per month as long as “the outlook for the labor market does not improve substantially … In the context of price stability’. 12/12/2012 CEQ expected: The Fed will continue to purchase $45 billion of long-term Treasuries per month but will no longer sterilize purchases through the sale of short-term Treasuries. Source: Leadenly (2013), US Federal Reserve System important CEQ In late November 2008, the Federal Reserve started purchasing $600 billion of mortgage securities. By March 2009, it controlled up to $1. 5 trillion of bank debt, including mortgage-backed securities, and Treasury notes, and peaked $2. 1 trillion in June 2010 (John& Ads, 201 1). To maintain high liquidity of bank, the Fed bought $30 billion in two to ten year Treasury notes every month. In November 201 0, the Fed started a second wave of quantitative easing which know as CEQ: purchasing $600 billion of Treasury securities and the principal payments will continue to be reinvested. A third round of quantitative easing “CEQ” was issued on 13 September 2012 and will last to 2015. The F-deader Reserve decided to launch a new $40 billion per month.
In addition, the Federal Open Market Committee (FOMCL) announced that the near fund rate will stay near zero at least through 2015 (Sunburn 2012). 2. 3 Regression Results and Main Findings The immediate impact of the CEQ policy should be the injection of liquidity of banks those were facing insolvency risks. There is hundreds of retail and investment banks closed and destroyed huge amount of money of private held during the SGF. Obviously, the long-term bond purchased by the central banks directly injects the money to them and improve the bank liquidity and revert the bankruptcy.
Additionally, banks could extend new credit by the process of treasury selling. On the other hand, through the purchasing of long-term bond by central bank, the price was driven up and the long-term interest rate was lowered. Figure 2 shows the 1 0-year bond yield and expected inflation rate during the period of CEQ to CEQ. Figurer ID-year bond yield and expected inflation Source: Yardmen (2014), US Monetary policy: CEQ & Market < http://wwn. yardeni. com/pub/monpolicyqe. pdf> During the CEQ period, Fed Reserve mainly purchased the short-term asset, such as SSE debt and MBPS.
The substantial increasing of money base had a big impact on the bank liquidity and expected inflation went up dramatically. In addition, market rapid reaction resulted in significant declines in long-term interest rates. Because the market had adapted to the CEQ, the yields slightly increased later may due to other economic factors. After the initial promotion of balance sheet of Fed Reserve during CEQ, the Federal Reserve stopped pursuing additional purchases in short-term asset. On the contrary, the central bank changes its policy in the CEQ period that operating the long-term asset (treasury) to prevent possible deflation.
Economist Martin Fieldstone argues that CEQ brought a rise in the stock market during the period, and it facilitated the consumption of people and superior performance of economy in late 2010 (Fieldstone 2011). On the other hand, the further decline of yield had the impact on the demand of private sector of long-term asset. Similar to CEQ, CEQ also involved the buying of MBPS. However, the initial announcement of CEQ achieved a decrease of the ID-year Treasury yield whereas CEQ achieved a 16 basis point growth (Nellie & College 2013). In sum, it seems that CEQ and CEQ did not pose direct impact on the significant reduction of the
ID-year Treasury yield. Thus, this suggested that CEQ as well as CEQ were not as effective as CEQ. By applying the quantitative easy policy in US, banks eliminated the insolvency risk and got the bailout from Fed Reserve through the direct money injection. By increasing the money base of lending, people enable to get excess credit from bank with a low lending rate and facilitate the investment activities. By pushing down longer-term yields and increase the inflation rate, the price of other assets was boosted, and the money spending was lifted.
Stronger asset price stimulates the consumption because people feel wealthier and more confident. Finally, the inflation helps the US economy by making American goods more competitive in abroad market. 2. 4 The Spillover Effect on Emerging Market According to Hudson (2010), injecting the CSS banking system with excess money will decrease the interest rates, promoting the capitalization rate of real estate rents and realize extra corporate income. This will inflate asset prices and rescue banks by pulling homeowners out of their negative equity by the process of excess wealth creation.
Although the CEQ is expansionary money policy of US, the programs have profound impact on other countries. Internationally, this policy forced foreign central banks receive less than 1% on the international reserves, while the US investors will enable do the speculative trading in foreign exchange and commodity market by borrowing “cheap dollars” to buy the government bonds from Australian, Europe and Asian, as well as corporate securities to make higher return (Hudson 2010). The worldwide concerns especially in emerging countries was regarded that there is possibilities of affecting the financial balance in them.
The most direct transmission of CEQ policy influence to Asia is via the injection of capital o them (Morgan 2011). The first stage of for the capital inflows on domestic liquidity condition is increase the base Of foreign exchange reserve. In April to September 2009, the total foreign exchange reserve of Asia emerging domestic economies boosted to 258 billion per quarter compare with the 15 billion during previous three months (Morgan 201 1). It seems a trade surplus in emerging economies. However, the depreciation of US dollar may be a source of trading loss to them that traded denominated In US dollar.
On the other hand, the excess capital inflow may arouse the credit expansion of ankhs. A lending booming could lead to an over-heating economy, which contributes to the inflationary pressure. In those emerging economies, the capability of risk analysis and risk solving of banking sectors is not complete and mature compare with developed economies. During this process, they disable to forecast the economic activities turmoil and do the corresponding adjustment. After a period of time, the threat of financial imbalance and collapse of asset price bubbles would appear which could arouse the credit crunch of banks and bankruptcy.
To cope with that, government should enhance the supervision of banking sectors, cut the domestic money base and suppress the credit growth and lending boom to prevent the over- heating economy and price bubble in time. 3. CEQ of LIKE Following the collapse of Lehman Brothers, The global financial crisis in 2008 led to central banks and government of all over the world take the measures to stabilize the economic conditions. The bank of England’s Monetary Policy Committee (MAC) is the central bank of UK. Table 2 presents the key announcement of decision on CEQ by MAC.
Tablet Key Announcement of CEQ policy in UK Announcement date Decision on CEQ February 1 1 ,2009 The February inflation report and the associated press conference gave strong indication that CEQ asset purchases were likely. March 5, 2009 The MAC announced that it would purchase EYE billion of assets over three months financed by central bank reserves, with conventional bonds likely to constitute the majority of purchases. Gilt purchases were to be restricted to bonds with a residual maturity of between five and twenty-five years.
May 7,2009 The MAC announced that the amount of CEQ asset purchases would be extended by a further EYE billion to IEEE billion. August 6, 2009 The MAC announced that the amount of CEQ assets purchases would be extended to El 75 billion and that the buying range would be extended to gilts with a residual maturity greater than three years. November 5, 2009 extended to IEEE billion. February 4, 2010 maintained at E 200 billion Source: Joyce & Lassos (2011 The Financial Market Impact of Quantitative Easing In The United Kingdom The CEQ policy was firstly adopted in March 2009.
The main activities of Bank of England was buying assets, mainly UK government bonds. The effect of these purchases was to reduce the gilt yields and to stimulate demand through a number of channels (Capitation, Mutual, Stevens & Theorists 2012). In the early times, MAC cut the bank rate in a graduate step from 5 percent at the beginning of 2008 to 0. 5 percent in March of 2009 (Joyce, Lassos, Stevens, & Tong 2011 Although Bank Rate had reached its lower bound, the effects were not so obvious. MAC felt that it was necessary to use untraditional methods to stimulate monetary conditions.
Initially, MAC decided to purchase asset, amount of EYE billion. And then this number was expanded gradually to E 125 billion in May 2009. In August 2009, this number reached to IEEE billion and to IEEE billion three months later. Finally, maintained at IEEE billion in February 2010. According to the research of Spatter (2013), it seems like that CEQ have positive but limited impact on lending growth. Figure 3 Figure 3 illustrates that the bank lending rate of I_J is not as favorable as US and Europe.
The lending growth of UK after 2009 was negative which means that the lending volume of UK between 2009 and 2011 decreased continuously. Credit squeeze of UK banks indicated the risk of bank insolvency. On the other hand, the small banks being the most affected because of certain degree of heterogeneity (Spatter 2013). This may be a good improvement as it may eliminate the gap between large and small ankhs in the lending market. However, the major banks need to take main responsibility to stimulate the economy.
In particular, if CEQ does not work in stimulating lending growth on large major banks, it is cannot spur the lending of whole market. One possible measure could be purchasing more asset and inject more money into the banking system in order to boost lending. An alternative could be enhancing the capitalization of the banking system which probably help to realize effectiveness of CEQ program. Figure 4 10-year government bond yield Except bank lending reduction, other index also reflected that CEQ policy of UK s not effective compare with US and Europe.
According to figure 4, we noticed that during the year of 2009 and 2011 after financial crisis, the ten- year bond yield of UK was not lowered as much as CSS and Germany Figure 5 Real GAP levels Because of ineffectiveness of quantitative easing policy, the recovery of GAP level of UK took more time compare with US after financial crisis. Figure 5 shows that the growth Of GAP Of UK lags behind US and Europe. However the effect of CEQ is not as favorable as US, there are still some positive effect on growth of GAP and inflation. 4. CEQ of Japan 4. 1 Backgrounds
Quantitative Easing monetary policy was used in Japan for three times historically: CEQ, CEQ and CEQ. CEQ is an unprecedented monetary policy experiment in world in 2001. Before CEQ, Japan’s economics was not optimistic and favorable. According to Hutchison (2000), during sass, Japan’s economics had numerous issues such as unemployment, deflation and so on. According to figure 6, the inflation rate during this period is extremely low and reached the minor number in 1999. Asian financial crisis just ended in 1998, the market required an inflation of economy to resist the economic recession.
Figure Japan inflation rate Figure 7: Short-term interest rate in Japan Source < http://vmw. frbsf. org/economic-research/fiIes/e12DOO-1 9a. pdf Before 2001, government of Japan had adopted some measure to stimulate their economy by using Zero interest policy (showed in figure 7). However, it did not work. The serious deflation problems required active management of monetary matters of Japanese government. 4. 2 QEI In March of 2001 quantitative easing monetary policy was firstly implemented in Japan. The current account balances (CABs) became the operating instrument of Japanese monetary policy (Rixtel 2009).
The initial target for CABs was 5 trillion yen, and this target was enhanced seven times, reached a target which range of 30-35 trillion yen in January 2004 ( Riesel 2009). And, it started with buying long-term Japanese government bonds to 400 billion yen per month (Riesel 2009). Figure 8 shows the implementation of CEQ . Figure 8 Composition Asset Balance Sheet Bank of Japan Figure 8 shows the stable increasing in the amount of government bond and securities of Japan during 2001 and 2006. In the mean time, the amounts of bills purchased by the bank of Japan began to rise at a much faster pace as ell.
The long-term Japanese government bonds purchasing could arouse a large scale of increment long-term assets that would remain for a long-term balance sheet of bank. The increasing purchasing of government bond and securities of banks of Japan enable the activity of interbrain money market. During this process, the size and function of interbrain money market was gradually recovered. Institutionalized call market was especially successful so that the call rate had become the new operating target rate of CEQ policy after the end of CEQ, from the outstanding balance of current accounts (Riesel 2009).
Beside, the excess reserves would stimulate lending which enable the banks inject the money into market. Figure 9 Although the money has been increased, the deflation problem was still there. Figure 9 illustrates the inflation rate during the CEQ period. It is obvious that the inflation rate still maintained in an extremely low level between 2001 and 2006. Although it slightly rebounded in 2005, the substantial drop incurred after that. Current balance sheet had increased, however Japan still cannot eliminate deflation.
Because of its ineffectiveness, the CEQ policy was ended in 2006. The reasons of failing to eliminate deflation are various. The most important fact may be the aftermath of large price bubbles in both equities and real estate in sass. Insolvent companies cannot pay the loans from banks. Banks decided to delay to collect on the collateral, hoping asset prices would improve. However, the price did not go up, a lot of performing loans dragged banks in to insolvency. Until the values of assets are completely recovered, it will continue to be a deflationary force in the economy.
On the other hand, after price bubbles, Japanese people preferred to buy and sell gold or treasury bond rather than put the money in banks because they were afraid of bankruptcy. Some people hold that the Bank of Japan gave up this policy too soon. When it started being effective in 2006, the government just decided to drop it (Hashish 2010). Other people believed that the government implemented this policy too late. Before 2001, there were no effective policies to deal with deflation, Japan lost big in 1 9905.
Tomboy Mason (Portfolio Manager in PIMPS) indicated that earlier to use CEQ policy, the more effective it would be (Hashish 2010). 4. 3 CEQ Because of the worldwide impact of financial crisis of US that erupted in 2007-2008, Japan was affected and was dragged into the global economic secession. The price increased rapidly and the nominal GAP growth rapidly, however, the real GAP did not improve too much (Kiowa & Taking 2009). From figure 1 0, we can clearly see that because of the terrible impact of SGF, the growth rate of exports, investments, and consumption and also GAP dropped substantially after 2008.
Figure 10: Growth Rates of GAP and Its Components The decline of private consumption indicated that Japan would experience more severe deflation. In response to that, Bank of Japan decided to follow US, reuse CEQ to stimulate market and economy. According to Bremen (2012), Bank of Japan policy toolkit was expanded to outright PU researches of corporate bonds and commercial papers, expansion of outright purchases of Jobs, a fund provisioning measure to support growth and fixed rate fund supplying operations.
In this stage, government and Bank of Japan used diversified ways to rescue economy, not only just buy and sell government bonds and treasury. Therefore, the increasing of current account balance was not notable compare with pre-2006(see figure 11). Figure 1 1 Current Account Balance at Bank of Japan Figure 12 shows the inflation expectation after 2008 of Japan. Inflation expectations in Japan appear to have a positive growth after 2008. At the end of period of CEQ, the inflation rate would be almost 1. 5 percent. This is a significant decline in inflation expectation compare with US.
However, in fact, that inflation expectation recently appears to have gone up sign efficiently above their historical average (Annotated, & Lie, 2013). This change indicated that the extra unexpected inflation may enable banks gain excess credibility. In addition, it illustrates that CEQ policies can play a good role in market on inflation and banking credit crunch if government and central banks could cake a set a realistic goal and sufficiently committed to achieving their goal. Figure 12 Inflation Expectations in Japan The result of CEQ was better than CEQ .