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A Brief History of Quantitative Easing

 9 min read / 

The first monetary policy experiment, which is now effectively known under the name of “quantitative easing”, finds its roots in the dramatic situation of faltering growth that the Bank of Japan had to face in 2001. After having proceeded with several open-market operations, aimed at lowering the overnight interest rates down to the near-zero level (as targeted by the Japanese Overnight Call Rate), Japan’s monetary operations started focusing on the outstanding balance of current accounts of commercial banks, with a target increase from 1¥ to 5¥ trillion, later raised to 35¥ trillion between March 2001 and December 2004.

The injection of liquidity into the banking system, which was planned to be in place until the consumer price index registered stably a zero percent or an increase year on year, together with the lowering of the risk of a liquidity shortage and the already low interest rates, created a solid base from which Japan’s recovery could take place. In addition to this, Japanese quantitative easing also aimed at stimulating new long-term investments with a large plan of long-term Japanese government bonds purchases whose effects were translated into a reduction in JGB yields and, therefore, in long-term interest rates.

The effectiveness of Japan’s QE program took longer than expected to show its results, due to the sick economy in which the policies had been made and the frail status of the banking sector, which, despite the larger amount of liquidity available, waited for more stable economic conditions before taking advantage of the monetary easing coming from the BoJ.

When in 2008, in the post-Lehman economic turmoil, it came the time for the Federal Reserve to plan the launch a quantitative easing in the US, everybody started looking back at the Japanese case. Japan’s exit from QE was announced in March 2006 and it was carried out through 3-4 month long operations aimed at restoring the markets on which the QE had the highest impact. In the end, the exit of Japan from this unprecedented monetary policy has been considered generally successful in stimulating the economy, despite not being able to fight domestic deflation. The Federal Reserve’s approach to supporting credit markets, described as “credit easing”, expanded the central bank’s balance sheet in the same way Japanese QE did between 2001 and 2006, but if the latter mainly addressed its monetary aid towards the banking industry and, more specifically, bank reserves, the American central bank’s plan targeted those markets more dramatically affected by the economic crisis.

The policy of large-scale assets purchases made by the Fed since 2009 can be divided in three different rounds: QE1, QE2, QE3. QE1, the first wave of asset purchases primarily made to revitalize mortgage lending and support the housing market, consisted of the purchase of agency mortgage backed securities, GSE debt and long-term government bonds. In order to support the housing credit market, agency MBS and GSE debt accounted for more than 80% of the total purchases, with a total of $1,250 billion spent for agency MBS and $200 billion for GSE debt. In 2010, to fight the still sluggish economy, the Federal Reserve launched a new QE plan (QE2), designed to dwindle long-term interest rates, with a new round of Treasury securities purchases for $600 billion, and to lower the risk of a Japanese-style deflation, raising inflation rates consistently.

After the completion of this second QE and with another attempt to tackle the weakness of markets and the stagnant growth, the Fed announced in 2011 the Maturity Extension Program, better known as “Operation Twist” (this name was first coined for a similar program in 1961, aimed at stimulating an economy still constrained by the gold standard’s limits). Unlike quantitative easing, this program had no effect on the size of Fed’s balance sheet, since the target to flatten the yield curve was met by exchanging $660 billion of shorter-term Treasury securities with an equal amount of newly acquired longer-term bonds. Despite this alternative monetary policy, US recovery was not yet on the horizon and this fact prompted the Federal Reserve to release a new quantitative easing plan in 2012.

QE3 had no planned end date, since its scope was too inject liquidity into the system (through the acquisition of $40 billion agency MBS, later raised to $85 billion per month), until when the markets did not start to show the hoped-for positive effects of this new economic boost (this is what has been commonly named “QE Infinity”).  After nearly 6 years of bond purchasing, in October 2014 the Fed put an end to his extraordinary QE experiment: solid job gains and a lower unemployment rate were recorded, and the higher level of strength of the US economy compared to the ones of other major countries (such as China, Japan or the whole Eurozone) lifted the value of the dollar. With a final balance sheet of about $4.48 trillion, the Fed’s QE can also be considered a success.

Over the period March 2009 to January 2010, while the Federal Reserve was in the middle of its QE1 plan, also the Bank of England released its first quantitative easing, a monetary measure taken to stimulate consumption and meet the 2% inflation target, after several unsuccessful attempts to the steer the economy out of the credit crunch lowering the Bank Rate. With a total asset purchase of £375 billion, the bulk of UK’s QE consisted of conventional gilts (UK government bonds), initially only with residual maturity between 5 and 25 years, but then extended to every gilt with a maturity greater than 3 years. Acting as a market maker of last resort, the Bank of England also carried on the Asset Purchase Facility program, acquiring high-quality private sector assets such as corporate bonds.

As for every other QE policy, quantitative valuation upon the macroeconomic effects of this monetary measure are difficult to be done, but, in the case of England, studies have shown how QE have contributed in giving a boost to the labour market, recording a decrease in unemployment rates, raising GDP levels by 3% and stabilizing inflation (whose rates are now falling, threatening the system of deflation, though).

As the dollar was becoming more and more competitive on the markets, in 2010 also the Bank of Japan started planning a new round of monetary easing, first, acting with a temporary Asset Purchase Program (Comprehensive Monetary Easing), acquiring mainly Japanese government bonds together with smaller amount of CP and corporate bonds (the peculiarity of this program was that risky asset purchases were included in the plan), then suspending this previous program in order to introduce, in 2013, a new quantitative easing. This “quantitative and qualitative monetary easing”, as for the aforementioned 2001 QE, was expected to depress longer-term interest rates but its main purpose was to steer the Japanese economy out of the deflation that had plagued the economy for nearly 15 years. Although the effects on bond yields have been relevant, the impact upon the whole economy, in terms of inflation and stimulus to the markets, has been much lower than expected. In order to keep boosting the economy, on 31st October 2014 the Bank of Japan announced a further expansion in the program, that would be conducted at a pace of 80¥ trillion per year. The effects of this QE implementation have been a plunge of Japan’s currency, positively influencing export-oriented businesses but without a similarly significant stimulus to the whole economy.

Since the creation of the euro in 1999, one of the primary objectives of the European Central Bank has been the maintenance of price stability throughout a dramatic series of economic upheavals. In order to keep inflation rates close to the target percentage, during the financial crisis years the ECB responded with a medium-term oriented monetary policy. After a first approach with a program of credit support (principally made of several LTROs and covered bond and ABS purchases), in 2010 the ECB announced the Securities Markets Programme, carried out in the euro public and private debt securities markets to provide liquidity to their frailest segments. It was the fear of a deflationary spiral what, in January 2015, finally lead the ECB to unleash its first quantitative easing plan, intended to last until September 2016 which could be extended until when inflation rates are acceptable.

The 2014 average inflation rate of 0.4% is expected to be brought below but close to 2% over the medium term, with a monetary easing that encompasses the previous ABS and covered bonds purchase programs and that is based on purchases of bond issued by euro area governments and agencies and European institutions in the secondary market, with a maturity range between 2 and 30 years. The limit of this monetary policy is due to the decision of the ECB not to buy more than 33% of each issuer’s debt, and no more than 25% of each issue. ECB projections are positive and show a 0.4% boost in inflation rates this year and a further 0.3% in 2016.

There has always been a lively discussion upon the effectiveness of an unconventional monetary policy like the one QE, in all of its variants, is and the incredibly different results that this easing plan has led to, in the countries whose central banks have adopted it, haven’t brought to a unanimous opinion (as previously analysed, QE has been successful in boosting the American economy after the financial crisis, as well as it has failed in fighting low inflation rates in Japan and in guaranteeing stable inflation rates in the UK).

However, what the monetary theory does not directly take in account is the psychological impact that the quantitative easing can have on people’s behaviours: if the economic situation is not stable and data lead to the worst expectations, an injection of liquidity into the system, as QE represents, can be seen as a great confidence booster in markets. It is all a matter of mind-sets: the more an economy is likely to grow and, in microeconomic terms, to enhance people’s well-being, the more the latter are encouraged to transform their savings into consumption or investments, starting a virtuous mechanism without which no monetary policy could succeed.

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