Q & A: Will the next step be more Quantative Easing?
Q Why the need for more QE? A Q Just what is QE? A Q What is the effect of QE? A Q Are we stuck with QE forever? A
As financial markets reel, bludgeoned by a cocktail of concerns about the strength of the world economy, investors are increasingly convinced that central banks will turn to quantitative easing. Fears about global growth may mean that central banks return to raising stimulus. After the financial crisis, central banks slashed their interest rates close to zero. It was then thought that attempting to push interest rates below the “zero bound” would be too dangerous. So monetary policymakers turned to QE. Themos Fiotakis, a UBS strategist, said that “few macroeconomic products of the great financial crisis have been as widely debated, loved and hated at the same time”. Policymakers may, however, have to consider it again. UBS said there is room for central banks to respond with more stimulus, “particularly from the US”. Traders are talking of a fourth round of Federal Reserve purchases, or “QE4”. Martin Enlund, a Nordea analyst, said: “Markets are behaving in a way consistent with a rising probability of a US, if not a global, recession. It’s up to global policymakers to respond.” Without the option of lower interest rates, policy-makers decided to try out QE in an attempt to stabilise their respective economies, and to boost demand. Central banks create new money, which is swapped for debt. Normally, they will buy up bonds issued by the governments of their own countries. But it is not unknown for central banks to buy up corporate debt also. This process increases the size of the central bank’s balance sheet. The US Federal Reserve went first, starting to buy bonds in 2008. It was followed by the Bank of England in 2009, and the European Central Bank early last year. The Bank of Japan’s QE programme is the largest of any of the G4 currency group – the US dollar, sterling, euro and Japanese yen – at almost 80pc of its GDP. QE is thought to affect the economy in two ways. The first is the so-called “portfolio effect”. Central banks buy bonds from the financial markets, swapping newly created cash for debt. This causes the price of bonds to rise and yields on them to fall. As the yields drop, these “safe assets” become less attractive to investors. It is hoped that money managers will then pile to other, more high-risk investments, such as stocks. QE’s second economic consequence is the “signalling effect”. By introducing asset purchases, the central bank makes it clear that interest rate increases are further away. Central bankers introduced QE as an exceptional tool of monetary policy, for extraordinary times. However, it is beginning to look like a permanent part of the financial landscape. Policymakers have been waiting for the economic recovery to mature before removing QE. Strategists at UBS said that they considered it “unlikely that central bank balance sheets will be reduced significantly within this cycle”. Indeed, to do so, central bankers would need a lot more time on their hands. It has been seven years since the last global recession. The next slump may arrive more quickly than QE can be safely withdrawn.