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EFFECT
OF
QUANTITATIVE
Declaration
I hereby certify that this material, which I now submit for assessment as a continuous
assessment project in Financial Services on the course DT365/4 BSc (Business and
Management) Year 4, is entirely my own work and has not been submitted in whole or
in part for assessment for any academic purpose other than in fulfillment for that
stated above.
Signed: .....
Date:
Daniel Flanagan
Signed: .....
Date:
Ben OConnor
Signed: .....
Date:
Cian OBrien
Signed: .....
Date:
Mark Draper
Signed: .....
Date:
Daniel Connell
TABLE OF CONTENTS
INTRODUCTION.............................................................................................................4
WHAT IS QUANTITATIVE EASING?.............................................................................4
WHERE HAS QUANTITATIVE EASING BEEN APPLIED
BEFORE?..............................5
Japan......................................................................................................................5
America..................................................................................................................5
United Kingdom.....................................................................................................5
EUROPES ADOPTION OF QUANTITATIVE EASING....................................................6
EXCHANGE RATE MOVEMENT...................................................................................6
Positive Effects for Irish Businesses of a Weaker Euro.........................................8
Negative Effects for Irish Businesses of a Weaker Euro........................................9
QUANTITATIVE EASINGS EFFECT ON STOCK MARKETS.....................................10
EFFECT OF LOW INTEREST
INTRODUCTION
In January 2015, Mario Draghi announced a quantitative easing package worth
1.1 trillion in order to help Europe in the fight against increasing deflation levels and
stagnant growth. The stimulus package will run through to September 2016 in an
attempt to boost inflation, make europe more competitive and to hopefully increse
growth.
This article seeks to examine quantitative easing and its previous uses, along
with the anticipated exchange and interest rate movement and their effect on Irish
businesses. Furthermore, the effects of quantitative easing on stock markets will be
reviewed along with the potential risks of implementing the quanitative easing
programme.
WHERE
HAS
QUANTITATIVE
EASING
BEEN
APPLIED
BEFORE?
Japan
Japan was the first to implement QE in 2001 because their economy was
experiencing high levels of deflation. The Bank of Japan decided in 2001 to launch
their QE programme after their failed attempt to reduce deflation and the collapse of
global IT industry (Bowman, Cai, Davies, and Kamin, 2011). Between 2009 and 2012
the BOJ purchased 187 trillion worth of assets. According to Fawley and Neely
(2013) the BOJ focused their purchasing on short and long term government bonds.
Since April 2013 the BOJ has acquired another 84 trillion worth of government
bonds (Allen, 2015). So there are no results yet whether QE has been successful for
the Japanese economy.
America
Since the financial crisis in 2008 the Federal Reserve (FED) has practised
quantitative easing four times (QE1, QE2, Operation Twist and QE3). To date the
FED has spent over $3 trillion on government sponsored enterprise debt, mortgage
back debt and long term treasury debt (Fawley and Neely, 2013). According to Walker
(2014) Americas QE programme has reduced interest rates for households and
businesses, helped with job creation and prevented the US slipping into another
recession. However according to Prof Martin Feldstein of Harvard University there is
a worry that by pumping large amounts of money into an economy it can lead to
higher inflation (cited in Walker, 2014).
United Kingdom
According to Joyce (2012) there was a risk that Consumer Price Index
inflation wasnt going to reach the 2 per cent target set by the British government.
With the risk present the Bank of Englands Monetary Committee announced their QE
plan to purchase assets and reduce the bank rate by 0.5 per cent. The Bank of England
focused on purchasing medium and long term government gilts (Mortimer-Lee, 2012)
and by 2010 the BOE altered their focus and purchased government bonds (Joyce,
2012). According to Allen (2015) the BOE has said that QE easing has had a positive
effect on increasing the price of bonds and shares along with increasing jobs.
However there is now a worry of deflation as inflation currently rests at 0.5 per cent
(Allen, 2015).
other currencies, namely the dollar and the pound sterling. Kenourgios et al. (2015)
found that there was a depreciation of the euro and an increase of its volatility before
and after the ECB's announcements of the implementation of a quantitative easing
programme. They explain that markets were anticipating the actions of the ECB and
reacted accordingly. Below is a 6 a month graph of the Euro/US Dollar rate:
namely the U.S. and the U.K., will benefit hugely from the weaker euro. According to
Power (2015) 64% of our goods produced are exported to non-euro markets. He also
identifies that over the past year the euro has lost approximately 24% of its value
against the dollar and over 16% against sterling. This means that Irish exporters will
receive a massive competitiveness boost as a direct result of the weak euro.
Power (2015) also explains that the agri-food sector could receive a timely
boost from the weaker euro. Ireland exports 85% of its food to more than 160
countries worldwide and the agri-food sector accounts for more than 10% of total
Irish exports (Teagasc 2015). Britain accounts for 38% of exports from the agri-food
sector so the weaker euro should increase agricultural exports to Britain and other
non-euro markets.
Colgan (2015) identifies the tourism sector as one that should incur substantial
growth in 2015 as a result of quantitative easing. The Irish tourism sector should reap
massive benefits from the weaker euro as British and American tourists will see this
as a great time to travel to Ireland.
Strauss and Gordon (2015) explain that essentially companies with high U.S.
dollar revenues will gain most from the weaker euro. They state that given the euros
fall has been sharpest against the dollar, companies with significant US or dollardenominated sales, such as pharmaceuticals, would eventually be among the biggest
beneficiaries (Strauss & Gordon, 2015)
Negative Effects for Irish Businesses of a Weaker Euro
Although the weaker euro increases our competitiveness, it will inflate the
price of imports. Importers will have to give away more euros to import goods from
non-euro markets. Power (2015) explains that Ireland imports more goods from
Britain than they export to them. He shows that in 2014, merchandise imports from
Britain totalled 17.3bn while exports only totalled 13.4bn. However, the weaker
euro may act as a stimulant for domestic growth as consumers and businesses may
look to purchase indigenous goods instead of importing foreign goods. This is
positive news for smaller businesses who only operate on a domestic level.
The weaker euro may have a negative impact on the airline industry, as the
price of fuel will be highly inflated due to the weaker euro. Strauss and Gordon
(2015) explain that low-cost airlines that buy fuel in dollars but have no dollar
revenues could be among the worst affected. However Ryanair has stated that it has
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From this evidence, it can be seen that publicly traded companies gain more
financial reward from a quantitative easing programme as empirical evidence shows
that markets appreciate in value on the back of a quantitative easing programme. It
can clearly be seen here that Irish shares have already reacted bullishly as investors
look to the stock market for higher yields.
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return on its cash deposits. As outlined in the graphs below the ECB marginal lending
rate and the 10-year government bond yield rates are at historically low rates.
13
14
15
recovery in which the phrase has been coined a balance sheet recession by Richard
Koo. This is where businesses are not looking to maximise their profits, but instead
are looking to repair their balance sheet after it was severely damaged during the
recession.
Businesses may look to capitalise on the low interest rates resulting from the
QE programme and spend money now, fearing an increase in interest rates in the
future. It is difficult to say for certain, given the disagreement going on amid
academics whether or not this will mean that Irish businesses will truly benefit from
the low interest rates and increase spending. Irish businesses may simply go on and
continue to repair their balance sheets and not look to maximise profits.
RISKS
Where there is an upside with regards to QE, there must be a downside too.
Quantitative Easing has only been around for a very short period of time, so the risks
havent been observed to the level they should be. QE is essentially tailor-made to suit
an economy that is experiencing challenges. The ECB in comparisons to the US and
Japan are unique as they operate a single monetary policy over eighteen different
economies within the Eurozone, which all have their own distinct challenges
(Deloitte, 2015). When the US began QE it was crisis driven but as time passed it
became orderly and thought-out, and they are a wonderful example as learning by
doing (Blinder, 2010).
So with regards the Central Bank, what problem will they face with QE? The
answer is none, as they are obliged to hit certain levels of inflation which are seen as
being modest. However, when inflation levels get unsustainable, the central bank will
need to tighten monetary policy (Deloitte, 2015). The growth of the central banks
balance sheet will become an issue if a T Bill defaults which is unlikely to happen, but
is still a major risk. A major risk for the growing Irish economy at this moment in time
is the danger of a double dip recession. This occurred in England in the back end of
2011 due to bank credit growth contracting by record amounts. This led the UK
economy into a double dip recession in 2012, seeing this occur only a few years ago
will lead to major worries for Irish businesses (Lyonnet & Werner, 2012).
A peculiar risk for the Irish economy to take in to account is that QE might
work too well. For instance it is difficult for the central bank to judge whether or not
16
they are using the right amount of QE. If the size of QE is not correct, there is a threat
of the central bank providing too much stimulus meaning the economy could grow at
a faster rate than it should be (Mortimer-Lee, 2012). With Ireland after going through
one of its worst ever recessions and housing crisis in its history, QE may add to the
woes of the past. As it signifies substantial risk to the stability of the bond market and
brings about volatility. If this volatility is to occur, the consequences on mortgages,
corporate borrowings and government re-financing would be liable to confine growth
(Quantitative easing: Implications for bond market volatility, 2012). If this transpires
the Irish economy will be back where it was seven years ago. Quantitative easing also
forces investors to move into riskier investments. With this materialising another
recession could be on the cards for Ireland (ECR Research, 2015).
As Ireland is a part of the Eurozone, there might be conflicting objectives
between the Irish central bank and the ECB. This is highly likely to occur between
one of the eighteen economies within the Eurozone (Deloitte, 2015). It might be for
the reason they feel the need to exit QE at a certain time and the ECB dont deem it
appropriate at that moment in time to leave QE behind (Mortimer-Lee, 2012). If this
emerges it might put ideas into other central banks minds and the whole programme
could all go into disarray as one economy can create a domino effect for others to
follow.
Nonetheless one of the biggest risks that might come with QE that will affect
businesses in Ireland is that commodity prices might increase to unsustainable levels.
According to Palley the Dollar exchange rate depreciation increases commodity
prices indirectly via the expected inflation effect, and directly because it increases
global commodity demand by making dollar priced commodities cheaper in the rest of
the world (2011, p12). This would have a huge effect on Irish businesses as the cost
of transport will rise considerably, along with the cost of exporting goods rising
significantly too. As stated in the New York Times, Mr. Draghis only objective
officially is to drive inflation towards the central banks goal of below 2 percent. If
inflation becomes too low or even worse outright deflation occurs; companies profits
will be cut, wages will decrease and unemployment will rise significantly (Ewing,
2015).
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CONCLUSION
The major quantitative easing package annonced January 2015 has been
implemented in order to stimulate growth in the eurozone economy. The above article
has analysed the positive effects of the stimulus programme on Irish businesses, along
with potential negative efects and associated risks.
As the ECB have committed to the mass purchase of eurozone government
bonds, this has increased the money supply within the european economy and
provides governments with more money to spend on both the private and public
sector. Similarly, the asset buying programme has provided banks with more money
available to lend, which may act as a catalyst for Irish businesses to expand and
increase capital expenditure on the back of lower borrowing rates. However, as a
result of the major debt overhang from the recession it may be feared that banks may
not be willing to lend or companies are not looking to expand and take advantage of
low interest rate but instead seek to deleverage balance sheets.
The QE annoncement has encouraged exchange rate depreciation which is
especially good news for Irish businesses as Ireland are an export oriented country.
The weaker euro has lead to a massive increase in competitiveness for Irish exporters,
although it will also negatively inflate the price of all imports. However this may also
be deemed positive, particularly for small Irish businesses, as it may act as a stimulant
for domestic growth.
The quantitative easing has also negatively effected the yields on government
bonds which has forced investors to move higher up the risk curve in order to increase
returns. Investors may look to equities, corporate bonds or property for the higher
yield they require, hence stimulating growth in the economy through the circulation of
money and increased consumption. As stock markets continue to appreciate in value
and investement rises this may increase consumer confidence and finally lead to
Ireland and Europe creating sustainable growth.
The impact of quantitative easing should have many positive effects for Irish
businesses, however this programme does not come without its risks. Early signals are
positive but the programme has only just begun. The programme is being
implemented across 18 different econmoies which will provide their own distinct
challenges. Also there is a chance that QE could create bubble like conditions if too
much stmulus is pumped into Europe. Ireland needs to be particularly careful of ths
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and needs to ensure that the the economy is structurally sound with no imbamlances
like we have seen before.
To conclude, the impact of quantitative easing should have many positive
effects on Irish businesses in the short run. However problems may arise when
tapering back measures are announced and it will be interesting to see if Ireland and
indeed Europe will be able to stand on its own feet once quantitatoive eassing has
finished.
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