Source: http://danielpryorr.wordpress.com/2012/05/30/quantitative-easing-or-government-stealing/
Normally a
central bank uses the official interest rate to regulate the money supply. The
idea behind it is simple: if the interest rate is high, it makes borrowing more
expensive and thus encourages people to save. This will reduce the money supply
in the economy (contractionary monetary policy). Conversely a low interest rate
makes borrowing more attractive than saving, thus increasing the money supply
in the economy (expansionary monetary policy).
This is an
important consideration since the supply of money directly correlates to the
amount of spending in an economy. An increase in money supply (a decrease in
the interest rate) will increase consumption spending and increase investment
spending – which is particularly useful when the economy is in recession
because it boosts the aggregate demand, which, in turn, creates the economic
growth needed to get out of the recession.
But a
question arises: what if an economy is in recession (low supply of money) and the interest rate is close to zero?
It is illogical for the central bank to lower interest rate below zero. So what
should it do? In terms of monetary policy, this is where quantitative easing
steps in.
Quantitative
easing is another way that a central bank increases the money supply of an
economy. It is the process of injecting money into the economy that is created
out of nothing. A colloquial term used here is “printing money”, but a central
bank hardly does that. Instead it is done electronically by increasing the value
in its credit account.
The central
bank then use this newly created money to invest in financial assets that is
usually owned by commercial banks or similar financial institutions. Therefore
the money created is “transferred” to them. This encourages financial
institutions to lend more to firms and individuals, which therefore (in theory)
increases the overall economic activity, stimulating economic growth.
This sounds
very good for the economy, but there are also consequences. Increasing the
money supply excessively by “printing money” will cause the currency to devalue
greatly, which might lead to unfavourable results like inflation or
hyperinflation. On the other hand, too
little money injected into the economy will yield no results. It is very hard,
if not impossible, to find out how much money is needed to produce the optimum
result.
In the year
2009, the Bank of England injected 200 billion pounds into the economy. It is
said that it “helped to increase gross domestic product by between 1.5% to 2%,
indicating that the effects of the programme had been ‘economically
significant’” (BBC)
There are
many analysts that disagree with this claim, and the thing is, and I quote from
BBC:
" The simple fact is, on one knows
how bad things would have been without QE (quantitative easing).
As BBC economics editor Stephanie
Flanders says: ‘ Quantitative easing may well have saved the economy from a
credit-led depression. We will never know.’ "
So is
quantitative easing effective and useful? It is hard to say.
Quantitative easing is being done in the United Kingdom to stimulate growth, but it is not yielding any favourable results, and is simply devaluing the public's savings. Consumer spending and investment has not increase since QE began several years ago. In fact, if you look at the economic figures, the British economy has shrunk since the Tory-LibDem coalition came to power in 2010. This is largely due to the fall in construction and manufacturing, the exact industries that QE is supposed to help stimulate. The British government must adopt a different approach to eeking out economic growth, and highly suggest that other countries in the same situation follow suit. Legislation should be decreed to prevent people from taking advantage of the welfare state and living off government money, when they are totally fit enough to get a job and work. Government spending on healthcare and social security should be reduced. This will not have a catastrophic effect on AD, if it is done properly. Savings can be made by cutting down bureacracy and expense-claiming schemes. The British government should increase spending on individual investments, most notably, infrastructure. British stagnation is further worsened by the fact that it has inferior infrastructure to its competitors of France and Germany. South-east England needs additional aviation capacity, and therefore jobs can be created by airport expansions or even brand new airports. Other jobs can be created by an increase in defence spending, as the military nowadays is highly capital-intensive, sustaining hundreds of thousands of manufacturing jobs. If defence spending were increased by about 20 percent, it would be possible to recoup all of the jobs lost in manufacturing. The government can also provide subsidies to new manufacturing firms who make highly exportable stuff, such as valves and utility equipment. Finally, the government should lower the tax and regulatory burden for SMEs, which are the biggest employers in the country. This provides people incentives to work, but more importantly, encourages entrepreneurship and therefore more investment. All of this will trigger new growth and as a bonus, in the long term, the government's debt burden can be reduced by the increased tax revenues due to the higher AD it has created.
ReplyDeleteYou have suggested a lot of spending and I don't think that is achievable right now, unless the government wants to go into more debt. The reason why the government is using QE to stimulate demand is because it is already running out of money to spend - increasing real spending right now will only make things worse. Also, cutting the health care budget and increasing spending on defense is not feasible and I don't think the government will do that anyway. Health care is more important to the general public and since it is all free, everyone relies on the government to support them. The general population will not be happy about such change, no matter how it might have a positive economic effect in the long run; it will only put pressure on the government. However I have to agree with you on the SMEs. I think these businesses should deserve more attention from the government as they have the real potential to stimulate growth. A reason why QE did not work as well as planned is due to the poor circulation of money, as a result not a lot of funding and support actually went to these businesses in the end. And I think this issue needs to be addressed and be dealt with. But I guess another reason why the government is using QE is because it serves as a very quick solution to the current financial problems. Ultimately, it is very hard to say QE is not effective because who knows what might have happened without it - the situation could be a lot worse than now.
DeleteQuantitative Easing in my opinion is the diluting of money, in plain terms. Money, means a lot more than just numbers and paper, it is backed up by the trust we have in the country that issues the specific currency. In theory, one can walk into a bank and exchange a note for gold. The American federal reserve actually has large amounts of gold to backup their currency. Now, the problem with QE is that-When money is diluted, it creates an illusion that the economy is unusually active, and that there is high amount of demands for all goods and services, or at least, a significant increase. As we all know, according to keynesian theories, the wages are "lagging behind" the rate of inflation. So, if the general population predicts a 5% rate of inflation, they should in theory ask for a 5% wage increase. But this is not a viable solution in the long run, as the workers will realize the impact of QE on the rate of inflation. The use of QE can be argues that it increases the extremes of the business cycles, making a situation worse. I am speaking from the viewpoint of a free market economist. However, if QE had not been implemented, the economy could fall into recession, or worsen the recession in other cases. So, in conclusion, I believe it is the amount of money injected into the economy, and the distribution of such funds between the different sectors that determines the effectiveness of the intervention.
ReplyDelete