The severity of the recent Global Crisis and the inability to generate a turnaround with ordinary policy tools forced policymakers to come up with new methods to revitalise economic performance. One of those tools is quantitative easing (QE). This short column introduces a collection of VoxEU columns by leading economists on the issue.
Expansionary monetary policy typically consists of buying short-term government debt to affect short-term interest rates. This policy instrument quickly reached its limit as policy rates reached near zero levels.1 Quantitative easing consists of buying other types of financial assets, e.g. long-term government bonds or mortgage-backed securities, with the objective of increasing the amount of liquid assets in the economy (starting with an increase in the monetary base) and pushing down interest rates more generally, which should be helpful for the ultimate goal of reigniting economic growth. The Bank of Japan pursued quantitative easing during the 2001-2006 period, when the term originated. During the Global Recession, the Bank of England took the lead and announced on 5 March 2009 that it would purchase £75 billion of long-term government bonds in the next three-month period.2 The latest addition is the expansion of the asset-buying programme of the ECB from €10 billion to €60 billion, which was announced 22 January 2015.
During the Global Crisis, central banks set out using mostly unexplored policy operations during turbulent and very unusual times. One could draw an analogy with a physician who faces a patient whose health is rapidly deteriorating and not responding to the usual medical treatment. Not willing to give up, the doctor tries to cure her patient with untested, possibly intrusive medication, even though she does not even know all the patient’s ailments. In the process of better understanding the failing of the economy and the search for a cure, central banks have not stood alone. There has been a healthy and at times critical exchange between policymakers, academics, and the public. An important forum for this exchange has been CEPR’s policy portal VoxEU.org. A new eBook, Quantitative Easing: Evolution of economic thinking as it happened on Vox, contains several of the VoxEU columns related to quantitative easing. Some columns are by policymakers explaining their policies, some are by academics who discuss related new research, some critique existing policies or point at risks, and some plead for quite different policies.
The economics behind quantitative easing
The first part of the eBook deals with the economics behind quantitative easing, both in terms of empirical support and in terms of possible theoretical justifications. Neither aspect is unquestionable. Conventional monetary policy influences the relative supply of short-term government debt and reserves. Such policies are believed to affect the economy because reserves are a special asset. One can think of QE purchases as two transactions: selling long-term government bonds (or possibly other assets) in exchange for short-term government bonds, and selling short-term government bonds in exchange for reserves. At the zero lower bound reserves are in abundant supply, and reserves and short-term government have become close substitutes. This means that QE will only affect the economy if changing the relative supply of long-term government debt relative to short-term government debt matters. Dominant asset-pricing theories, such as the Capital Asset Pricing Theory (CAPM), and most macroeconomic models predict that quantitative easing would not work. Consequently, to justify QE policies policymakers have relied on other theories and in particular on portfolio balance models of the 1960s. The columns in the first part of the eBook deal with this issue in different ways.
Providing empirical support for QE policies and evaluation of its effectiveness ex post is difficult. The reason is that one has to disentangle the effect of QE from the effect of the event that triggered the central bank to initiate the QE programme. For example, suppose that the central bank decides to implement a QE programme because it foresees a further deterioration in economic growth. Even if the QE programme is successful, then it may still be possible for the programme to be followed by lower economic growth. Strategies to deal with this dilemma are also part of the first part of the eBook.
Risks associated with quantitative easing
QE policies have not been uncontroversial, and the second part of the eBook deals with risks associated with QE and criticism. One risk factor that was put forward as soon as QE started is that raising liquidity in the financial sector to unprecedented levels will at some point unleash massive spending capacity and generate inflation. Interestingly, other contributions that are critical of QE question whether it is capable of affecting spending in an economic environment like the one we observed during the Great Recession. If true, then inflation would be only a quite distant risk.
Quantitative easing in the Eurozone
In January 2015, the ECB got serious about QE. The third part of the eBook deals with QE in the Eurozone. QE policies can best be viewed as a mix of fiscal and monetary policies. The fiscal aspect of QE makes QE a thorny issue in a monetary union that is not a fiscal union, especially when several of the countries in the monetary union are in or close to a sovereign debt crisis. The contributions in this part of the eBook analyse these risk factors and discuss how they can be dealt with.
A key aspect of QE has been its scale. Central bank balance sheets have ballooned to multiples of their pre-Crisis levels. The last part of this eBook deals with exit strategies and the associated risks. Seven years since the collapse of the financial system following the Lehman Brothers bankruptcy, we now seem to be at a point where some central banks, the Federal Reserve and the Bank of England in particular, are close to begin the process of reversing the very loose monetary policy they have pursued in the last seven years. But this process is likely to go very slow. Moreover, other central banks, the ECB in particular, are not yet in such an enviable position. This means that QE is likely to remain a fascinating policy that is likely to be discussed on Vox and elsewhere for quite some time to come.
Armstrong, Caselli, Chadha and Den Haan (2015), “Risk-sharing and the effectiveness of the ECB’s quantitative easing programme”, VoxEU.org, 23 October.
Den Haan, W. (ed.) (2016), Quantitative Easing: Evolution of economic thinking as it happened on Vox, a VoxEU.org eBook.
IMF (2013), “Unconventional monetary policies – recent experience and prospects,” IMF, April.
1 See Armstrong et al. (2015a) for a discussion on the feasibility and desirability of negative policy rates.
2 Later in the year, the programme was increased to £200 billion. A detailed overview of unconventional monetary policy programmes can be found in IMF (2013).