Why quantitative easing isn’t the cure
Like the proverbial Pied Piper, the coronavirus pandemic has escorted all global economies into their most turbulent era of existence. As governments have rolled out financial aid during the debilitating epidemic, perhaps a big question needs to be answered: Is there a way to ensure that the benefits of all the government spending ultimately go to local economies rather than financial and corporate elites?
Deflation and secular stagnation are the absolute risks of our debilitating times. Forceful quantitative easiness (QE) and forceful structural reforms, including currency adjustment, are what is needed, to keep economies afloat.
Every time the Fed in the United States implements “quantitative easing,” aka printing more money, in a modern and developed economy, two things go up: Taxes and inflation. Obviously, when taxes and inflation go up, more jobs are lost.
I have reasons to suspect that a lot of people don’t realize that the money to finance the recovery is actually being created out of, say, thin air by the central banks in the US or in Canada or the Bank of England in the UK. The same practice is adopted in Bangladesh, Pakistan, and India.
When nations are faced with currency wars, one of the easier ways to stimulate the economy is to weaken the national currency. And, there are established ways of achieving this.
Money from thin air
The central bank uses this new money (created from thin air) to stimulate the economy by purchasing government bonds, either directly from the government or from financial corporations that already own government bonds. This is what we know as the quantitative easing (QE), and it is something US, European, and Japanese central banks have been doing for more than a decade.
For those who protest that money can’t be created out of nothing, the answer is still very simple: Why not? That’s exactly what commercial banks do. If you go into a bank in America, and ask for a $200,000 mortgage loan, the bank simply creates ledger entries for the $200,000. This money didn’t exist until you got the loan.
Not surprisingly, Bank of Canada actually has a history of creating money out of nothing. After its establishment as a crown corporation in 1938, the Bank of Canada (BoC) used money creation to buy treasury bills. In essence, the Canadian government, through the sale of these bills to the BoC, was borrowing money from itself. The borrowed money was used to fund public initiatives.
Think of post-confederation infrastructure projects in Canada’s province, the Trans-Canada Highway, the universities and airports. Think of universal Medicare and Old Age Security.
In the year 1974, Canada largely abandoned its successful experiment in self-funding and began borrowing from the private sector. Result: Over the next 40 years, Canada paid a cumulative amount of $1.17 trillion in interest to private sector financial institutions.
The ongoing pandemic experiment with quantitative easing has the potential to lead us back to the original mandate of the Bank of Canada. However, everything depends on what the BoC does with the money it is now creating.
Quantitative easing can take two forms. The BoC can purchase newly issued government bonds directly from government, as was done 50 years ago. Government then spends this money into the economy.
Alternatively, the BoC can plough money into the economy by buying the bonds from financial institutions that already own government bonds. In this case, the government will enjoy no control over how the money will be spent.
Theoretically, these institutions will use the money they receive from selling their bonds to provide needed loans to the business community. There is substantial evidence, however, that the principal beneficiaries of this form of QE are largely asset managers, hedge funds, wealthy property owners, and the banks themselves.
Local economies have not benefited. Today, the Bank of Canada currently seems to favour the latter approach.
The BoC’s weekly $5 billion bond purchases over the next 12 months will be from the private sector. When this is practiced, Big Finance is, no doubt, pleased.
What we really need to have is a quantitative easing strategy for the people -- one where the Bank of Canada returns to its original mandate and finances the government through directly purchasing its bonds.
The next question remains: What will all this lead us to?
Canada’s administrative provinces and municipalities could have regular access to low interest loans from the federal government. The power of money creation could be mobilized for building needed infrastructure, addressing environmental challenges, strengthening local economies, and promoting full employment.
Are there any legislators in Canada pushing for this? At this time of crisis, the need to do so is certainly there.
Back to basics
Quantitative easing is an unconventional monetary policy tool used after conventional tools have become ineffective. The unconventional tool had helped get the US out of the Great Recession, but 2019 is not 2008, and there are many who believe QE is no longer a magic elixir.
That doesn’t include President Trump, who has repeatedly called on the Fed to lower interest rates, including in the spring, when he also pushed for the Fed to employ quantitative easing in order to give the economy and stock market a boost. In an April 5 tweet he had said: “You would see a rocket ship.”
And that was after a first quarter GDP of 3.1%. Last week’s GDP print of 1.9% compelled him to return to the topic of lower rates again, calling out Fed chief Jerome Powell for not keeping pace with other countries in lowering their key rates.
There was a time when quantitative easing by the Federal Reserve was like the cavalry riding in to save the day. Then-Fed chief Ben Bernanke, a student of Great Depression, utilized the approach to add liquidity and reserves to the financial system when it looked like the banking industry was on the verge of collapse in 2008. Let me try and explain how QE works. The Fed buys specified amounts of financial assets, thus raising the prices of those financial assets and lowering their yields.
Specifically, the Fed bought mortgage-backed securities at a time when many institutions wouldn’t touch them, as well as treasury notes and bonds. Collectively, these actions made sure that financial institutions wouldn’t be left with worthless debt instruments (like some of the MBSs).
It pushed down interest rates across the board with such large (quantitative) actions, making borrowing cheaper for consumers and businesses alike (that’s the “easing” part). The idea is that individuals and corporations could borrow money cheaply for a long time, stimulating the economy.
By 2014, following three rounds of QE, the Fed’s balance sheet was approaching $4.5 trillion, compared to a pre-financial crisis balance sheet in 2006 of less than $900 billion. The approach had worked. But how do you undo quantitative easing? By shrinking the Fed’s balance sheet.
In 2017, under the guidance of Chair Janet Yellin, the US Fed had started to “normalize” its balance sheet by not reinvesting the proceeds (money) when the debt securities matured. Without the Fed as a customer in the financial markets, issuers had to raise yields and lower prices to be competitive. Fortunately, the effects on interest rates have been modest because the normalization has occurred over a number of years (until a recent blip, which we’ll address in a moment).
The return to “normal” allows the Fed to use QE again in the future if conditions call for it. The debate continues over what those qualifying conditions are.
Another significant question arises: Will QE likely favour or stimulate growth?
Many on Wall Street don’t believe that another round of QE -- or even continuing to lower the Fed Funds rate directly -- will stimulate more growth. Ryan Severino, chief economist at JLL, puts it this way: “You can’t say we’re in the best economy we’ve ever seen but we need quantitative easing to improve our situation.” Severino believes that lower interest rates are not the issue with tepid economic growth.
“Investment by businesses fell in the second quarter. The things that are holding them back are policy uncertainties, including trade uncertainties, not interest rates.” And he worries that when the next recession comes, QE will be less effective. “We’d be using a lot of our monetary artillery where it won’t have a lot of impact.”
The QE argument also reared its head last month when the Fed had to infuse the financial system with cash when there was a shortage of liquidity for member banks in overnight transactions. The momentary spike in rates, and the entry of the Fed to calm the markets down, led Chairman Powell to announce that the Fed will be buying $60 billion of short term debt each month. To a lot of people, that sounds like quantitative easing.
Nancy Davis says it’s not QE because the Fed will be buying short term, not long term, debt. “In reality, those purchases should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis.”
Another round of QE might not have much of an effect anyway. Business surveys show that CEO’s are less interested in lower interest rates and more interested in a clear direction on trade policy because of how it affects the economy and business investment. “If companies become too pessimistic,” says one expert “it’ll eventually spill over into hiring and wage increases. That could affect the consumer.”
A history of failure
Quantitative easing is just the latest chapter in the Federal Reserve’s 100-year history of failure. The American people have suffered long enough under a monetary policy controlled by an unaccountable, secretive central bank. Is it the right time to finally audit -- and then end -- the Fed?
Several years of tepid GDP in the US growth has proved that the formula for growing the economy is not always as simple as lowering interest rates. “But if the only tool you have is a hammer,” says a CEO, wishing to remain anonymous, quoting his colleague, “then everything looks like a nail.”
QE may qualify as a monetary hammer, but today’s moderately growing economy is not necessarily a nail. It just looks like one to some people.
Fiscal policy is not a panacea; it must be used with monetary policy. Central banks, businesses, and politicians must rally cooperatively to create growth.
Long before citizens had fretted the demise of quantitative easing, it fretted its existence. It proved the reverse of its image, an anti-stimulus, and economies have done OK not because of it, but despite it.
Nazarul Islam is an educator based in Chicago.