Question

Why has Quantitative easing met some backlash from economists? What are the drawbacks for QE and their potential ramifications?

Answer 1

Popular media's definition of quantitative easing focuses on the concept of central banks increasing the size of their balance sheets to increase the amount of credit available to borrowers. To make that happen, a central bank issues new money (essentially creating it from nothing) and uses it to purchase assets from other banks. Ideally, the cash the banks receive for the assets can then be loaned to borrowers. The idea is that by making it easier to obtain loans, interest rates will drop and consumers and businesses will borrow and spend. Theoretically, the increased spending results in increased consumption, which increases the demand for goods and services, fosters job creation and, ultimately, creates economic vitality. While this chain of events appears to be a straightforward process, remember that this is a simple explanation of a complex topic. Reserve-induced effects are independent of the assets purchased and run through the impact of reserve expansions on bank balance sheets and the resulting bank portfolio rebalancing. For evidence, we analyse the reaction of Swiss long-term government bond yields to announcements by the Swiss National Bank to expand central bank reserves without acquiring any long-lived securities. The data suggest that declines in long-term yields following the announcements mainly reflected reduced term premiums, consistent with reserve-induced portfolio balance effects. Expansionary monetary policy to stimulate the economy typically involves the central bank buying short-term government bonds to decrease short-term market interest rates. However, when short-term interest rates approach or reach zero, this method can no longer work (a situation known as a liquidity trap). In such circumstances, monetary authorities may then use quantitative easing to further stimulate the economy, by buying financial assets without reference to interest rates, and by buying riskier or longer maturity assets (other than short-term government bonds), thereby lowering interest rates further out on the yield curve.Quantitative easing can help bring the economy out of recession^[3] and help ensure that inflation does not fall below the central bank's inflation target.^[4] Risks include the policy being more effective than intended in acting against deflation (leading to higher inflation in the longer term), or not being effective enough if banks remain reluctant to lend and potential borrowers are unwilling to borrow. According to the International Monetary Fund, the US Federal Reserve System, and various other economists, quantitative easing undertaken following the global financial crisis of 2007–08 mitigated some of the economic problems after the crisis. It has also been used by several major central banks (Federal Reserve, European Central Bank and Bank of England) in response to the COVID-19 pandemic.

Part of the U.S. Federal Reserve’s quantitative easing (QE) programs in the wake of the 2008 recession focused on purchases of mortgage-backed securities (MBS). While doing so helped revive mortgage finance lending, it also crowded out bank commercial lending to firms in other industries, leading to a decrease in business investments, according to a recent study coauthored by Wharton finance professor Itay Goldstein.QE programs in the future could learn from that experience to have a more widespread impact, Goldstein noted in a recent interview on the Wharton Business Daily show on Sirius XM. “The MBS purchases caused unintended real effects and … Treasury purchases did not cause a large positive stimulus to the economy through the bank lending channel,” notes the study, titled “Monetary Stimulus and Bank Lending,” which was published in the Journal of Financial Economics. Goldstein’s co-authors are Indraneel Chakraborty, associate professor of finance at the University of Miami Business School, and Andrew MacKinlay, assistant professor in Virginia Tech’s department of finance, insurance and business law.There is an intense debate going on in the first-class cabin of Economics Airlines about the direction in which our plane should be pointed. And while those of us back in the cheap seats don't get to help decide, knowing where we will land is of intense interest to all of us. This week we listen in on the debate, in the form of speeches and academic postings passed back from first class for the rest of us to read. This type of debate also occurred when Greenspan held rates down at an abnormally low level for a very long time. The unintended consequence of that move was a housing and debt/leverage bubble. Are there potential unintended consequences to Bernanke's current monetary policy, which some are calling Quantitative Easing Infinity.