Through the last two decades of relative economic uncertainty the conventional tools of monetary policy, which consist of influencing short term interest rates (toward the zero lower bound), have become stagnant in stimulating economic activity. This has been evident in the repercussions of the 2008 global financial crises. Following the success of ‘quantitative easing’ introduced by the Japanese government, to cope with the deflationary pressures that followed the bursting of the real estate bubble in the 1990s, other governments have turned to unconventional methods to kick-start their economy. Current interest base rates in the UK and the US are set toward the zero lower bound, meaning the further ability of conventional monetary policy to drag economies out of bust into boom is limited and will prove slow. The objective of this review is to gauge understanding of quantitive easing, by reviewing supporting and opposing empirical evidence and literature.
Firstly, with traditional policy instruments set as low as possible, governments must confront how to further ease policy as the economic out-look becomes increasingly bleak; they turn to the purchase of government bonds. The primary aim of monetary policy is to contain inflation and achieve price stabilisation The first notable case of quantitive easing followed the bursting of the real estate bubble in Japan in 1990. The Bank of Japan purchased government securities from the banking sector to boost the level of cash reserves in the banking system (Joyce, 2012.) The BOJ purchased these assets March 2001 through March 2006, which cemented the long term interest rates toward the lower zero bound. Ugai, 2006 gathered secondary research combined with his own primary research and determined that the announcements of QE implementation had a more significant effect on interest rates than the BOJ’s commitment to unconventional monetary policy itself, quoting: . However, there are arguments that break down the transmission of Oda & Ueda (2005) took a regression on the purchase of Japanese government bonds and the Bank of Japan’s current account balances. They establish a statistically significant positive relationship between the purchases of government bonds in each 3,5 and 10-year interest rates on the government current account balance. Also for each individual interest rate they find a negative relationship, although it is weak and not statistically significant it suggests quantitative easing did have an impact. Supporting Oda & Ueda in 2011 Bowman identify a ‘robust, positive, and statistically significant’ relationship between increased bank liquidity on lending in Japan, suggesting that the expansion of reserves associated with quantitve easing likely boosted the flow of credit.
Other literature that supports that quantitive easing does succeed in reducing upward pressure on furutre long term interest rates are Gangon (2010.) Whom finds the primary asset purchases appears to work is the risk premium on the asset being purchased. The purchases of the long term assets pushed up the price of the long-term assets and therefore lowers the yield. This meanwhile increasing the amount of short-term, no-risk bank reserves held in the private sector, however a higher premium is expected to make this adjustment, known as ‘portfolio balance effect.’ The notion that Federal reserve’s initial large scale asset purchases were successful in reducing medium and long-term interest rates, including those by D’Amico and King (2010), Krishnamurthy and Vissing-Jorgensen (2011) and Hamilton and Wu (2012). D’Amico found that on average for every $1 billion purchased in treasury bonds increased price on securities purchased by about 0.02%, which translates to a yield increase of about 0.7 basis points per $1 billion. The strong significance supports the hypothesis that purchasing of treasury securities have significant effects on yields.
Krishnamurthy and Vissing-Jorgensen (2011) discuss through which channels quantitive easing can influence interest rates in the US. Not focusing solely on treasury rates, as quantitative easing works through several channels, they find evidence of a signalling channel, an increase in demand for long-term safe assets, and an inflation channel for both QE1 and QE2. they speculate the effects of quantitive easing on the interest of particular assets (e.g. Mortgages) depend critically on which assets are purchased. Concluding that Mortgage-backed securities purchases were crucial in QE1 to lowering mortgage-backed security yields. as well as corporate credit risk and thus corporate yields. For QE2 purchases had a disproportionate effect on Treasuries and Agencies yields, relative to mortgage-backed securities. With yields on the mortgage backed securities falling mostly through the market’s anticipation of lower future federal funds rates.
Unconventional monetary policy measures were also used, and to some extent deemed successful, in the UK. The Bank of England introduced quantitive easing strategy like many other struggling economies following the 2008 crises. Initial asset purchases started between march and November 2009 where the monetary policy committee initially purchased £200 billion in assets consisting mainly of mostly government debt or gilts (Bank of England.) Since purchasing a further £175 billion up to total of £375 billion spent on quantitative easing. Meier (2009) speculates that unconventional monetary policy (in the UK) can be effective if it convinces the public of a looser-than-expected future policy stance, relative to developments of inflation. Secondly, if quantitative easing directly reduces risk premia on shorter term assets or releases quantitive restrictions in financial markets, providing liquidity which allows the commercial banks to lend money through loans or invest the money more easily. The success of monetary policy in England is shown by the continuation of The Bank of England’s QE strategy despite this however as stated in the 2015/16 report that at some stage in the future the ‘monetary stimulus provided by the asset purchases may be wholly or partially unwound.’ The process of selling these gilts may increase the yields on guilt’s to where they would have been in the absence of the whole quantitative easing programme. However, these are unreliable comments as quantitative easing in the UK has been a prominent tool of monetary policy since the economic crises.
Research done by Christensen (2012) investigating the effects of QE in the UK and the US. He in conjunction with Ugai (2006)’s assessment of the impact of the BOJ’s announcements. He finds that announcements of UK & US central bank’s future bond purchases, pushes up the price of the bonds purchased and the prices of close substitutes and push down the related term premiums and yields. However, he found differences between the transmission of QE in UK and US economies. In the US, longer maturity interest rates fell nearly in synchronisation with government yields of a similar maturity, while in the UK, long-maturity interest rates fell by a small portion of the decline in similar maturity UK gilt yields.
It is taken that dissimilar responses of long term interest rates in the two countries, suggest that different channels may have been at work at the time. Whether or not these differences in transmission of QE are due to different preferences or economic systems in the countries is unclear however it is speculated that specific financial market structures or central bank communication policies could be accountable. The US the Federal reserve purchased $3.7 trillion on 10 year equivalents but took into consideration the markets in which it was buying these assets. To quickly and efficiently implement the effects of the purchases, the New York Fed hired external investment managers to execute these purchases, highlighting the importance of purchasing the appropriate assets. The importance of this could be the reason between the varying long-term influences between the implementation of US/UK QE.