Dec 23, 2008 For Private Circulation only 3
Unconventional monetary measures
After exhausting all the conventional measures to spur the demand and stimulatethe economic growth being failed, the Fed is left with fewer options now. It isexpected that the Fed will take some exceptional measures like QuantitativeEasing (QE) which is a tool of monetary policy also known as
printing money mechanism
. This is used usually to fight domestic deflation. Deflation is apersistent decrease in the general price level of goods and services only whenannual inflation is below zero percent resulting in an increase in the real value ofmoney - a negative inflation rate. All developed economies are in recession andare expected to see deflation by the second half of the next year. Inflation in theUS has pegged at 1.1%, in Japan 1.7% and in the Europe area at 2.1%. Theclassic example is Japan which has experienced unprecedented recession anddeflation for more than a decade. The Bank of Japan has been maintaining short-term interest rates at close to their minimum attainable zero values since 1999.However, it’s still debatable how these measures are effective to such deflationarysituations.
Under Quantitative Easing (QE)
, the central banks
commercial banks withexcess liquidity to promote private lending, leaving them with large stocks ofexcess reserves, and therefore little risk of a liquidity shortage. It also involves
the reserve requirements and
buying treasury bonds
for cash to offsetthe reduction of money supply in the private sectors due to the collapse of creditthrough "open" market operations. Moreover they
buy asset-backed securities,equities,
extend the terms
of its commercial paper purchasing operation.
How the QE is effective in buoying the economy?
The Bank of Japan’s QE policy was introduced in March 2001 and terminated inMarch 2005. The policy was introduced with the intention to open-up a newpossibility for further monetary easing when the interest rate was already as low aszero. The policy was unprecedented and was an ambitious experiment by itself.The effectiveness of it has been a point of great controversy since its introduction.Several empirical studies have confirmed positive macroeconomic effect of the QEand have found out that the increase in the excess money led to the increase inaggregate demand and helped the economic recovery since 2002.
However, noeffect has been established on expectations and portfolio rebalancing byinvestigating the increase in Current Account Balance (CAB) targets and increasein government bonds purchases by the central bank. It’s very cumbersomeexercise to quantify the exact effect of such measures but the consensus is thatthey have positive effect on the economy.