QUANTITATIVE EASING: A NEW TOOL IN THE HANDS OF CENTRAL BANKERS – Dr. BOBBY SRINIVASAN AND Dr. SUDHAKAR BALACHANDRAN

November 24, 2014 | Posted by bobbysrinivasan << back to blog

After a long time, our friends Joe (Janakiraman) and Swami decided to have a conversation about quantitative easing. Joe was always confused about the coinage of this term and needed clarity.
Joe: Tell me. What does this term quantitative easing stands for? I don’t understand as to which quantity and who is easing it?
Swami: Quite funny, Joe. Quantitative easing is a procedure or method employed by the Central Bankers to buy financial assets (mostly bonds, sometimes also equities). This method will reduce the financial assets in circulation and replace it with liquidity in the system. This is done hoping that demand for money would be met.
Joe: I have read in my textbooks that whenever the central bank wants to add liquidity to the economy they will lower the discount (repo) rate. Why is this needed?
Swami: Precisely. Quantitative easing starts after the central bank pushed the interest rates to zero. The central bank in this case is not targeting interest rates to be achieved but rather the quantity of assets to be purchased.
Joe: I read that in the US that the quantitative easing has come to an end. Then what happens?
Swami: You are correct. Janet Yellen, Federal Reserve Chairman has announced as of October 2014 that the Fed will not be buying anymore bonds in order to add liquidity to the system.
Joe: Why all of a sudden this announcement and what she had planned to achieve and whether it is achieved?
Swami: We need to trace back the financial history of the US. When the sub-prime hit the US in 2008, liquidity in the global financial market disappeared enormously. As you know, when this happened, many banks and the financial institutions went “belly up”, including the well-known Lehman Brothers. The, then, Federal reserve chairman, Dr. Ben Bernanke acted swiftly and introduced the quantitative easing with a target of purchasing nearly US $800 billion worth of government bonds. Since then, the Fed has added more and more liquidity. After six years, since the introduction and after buying US $ 3 trillion worth of bonds, Janet Yellen called it quits.
When the quantitative easing was introduced, the US economy was in a tail spin. Nearly 700 to 800 thousand jobs disappeared every month. The unemployment rate hit more than 10% and the effective unemployment (adjusted for part-time and dropped job seekers) touched 17%.
Now things are looking up. Every month nearly 200,000 jobs are created and the unemployment rate has dropped to 5.8%. For the US, good news is everywhere. Small-cap stocks in the US have gone up by 10% and the crude oil price is heading lower.
Joe: So can we then conclude that quantitative easing is a tool invented by the US which has achieved a major economic recovery?
Swami: Wait. Don’t be in a hurry. This jury is still out. Japan is now doing it. Let us talk about it in the next blog.

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