Quantitative Easing Research Paper

Pages: 12 (3744 words)  ·  Bibliography Sources: ≈ 12  ·  File: .docx  ·  Level: Master's  ·  Topic: Economics

¶ … Easing

In early November 2010, the Federal Reserve in the United States announced what has been termed a second round of quantitative easing, a seldom-used instrument of monetary policy. The technique is controversial and many feel risky, but the Fed believes that given the economic situation, this round of quantitative easing was necessary to help stimulate the American economy. The underlying economic situation was indeed challenging -- high unemployment, slow GDP growth and interest rates up against the zero bound. With many of the more conventional monetary policy tools unavailable and fiscal policy tools unviable politically, the move to quantitative easing was made. Despite the risks associated with the tool -- higher inflation and currency devaluation -- quantitative easing is a necessary form of monetary policy to prevent economies from experiencing deep recessions, because its stimulative effects can cause banks to lend, which allows businesses to obtain credit for equipment purchases, employing new workers, and reducing export costs as well.

Buy full Download Microsoft Word File paper
for $19.77
The underlying macroeconomic environment can be characterized as a prolonged recovery from recession. A recession is defined as a period where GDP is falling economic activity spread across the economy, lasting more than a few months and visible in a number of indicators including real GDP, real income, employment, industrial production and wholesale-retail sales. According to the NBER (2010), the recession that ultimately led to the use of quantitative easing lasted from December 2007 to June 2009. In the period since that point, the economy has been in a slow recovery. The NBER does not differentiate between recessions and depressions in its terminology (NBER, 2011).

Research Paper on Quantitative Easing Assignment

Another important definition in this discussion is that of inflation. Broadly speaking, inflation is the degree to which the price of goods and services changes in an economy over a given period of time. There is considerable debate among economists as to the precise measures of inflation that have the most validity when discussing the state of the economy. Mankiw (2003) argues that the best measures of inflation incorporate primary sticky information -- prices that once changed are likely to remain changed -- and that inflation can be related to expectations of future movements in the state of the economy. The latter point is important in understanding the merits and critiques of quantitative easing.

Quantitative easing is itself a controversial term. Bernanke argues that QE refers to policies that seek to change the quantity of bank reserves, while his recent program -- that was dubbed QE2 in the media -- refers to the purchase of $600 billion in U.S. bonds as a means to inject money into the banking system (Robb, 2010). The Bank of England disagrees, and explains quantitative easing as a policy where the central bank buys assets -- either government bonds or private bonds -- as a means of injecting money into the banking system and thereby the economy as a whole (Bank of England, 2008).

By whatever name, the practice of buying assets in order to inject capital into the economy is controversial because some of the impacts of such a policy have on the economy. On the positive side, the underlying theory of QE is that with more money in the banking system, the banks will be better able to lend, spurring growth. The downside -- from the perspective of some -- is that the policy will result in runaway inflation and currency devaluation (Ugai, 2007). This paper will analyze both the positive and negative impacts of a quantitative easing policy as defined by the Bank of England, and will argue that such a policy is necessary in the current U.S. economic climate to spur growth. The conditions of the liquidity trap in particular make the use of this relatively unconventional policy a necessity.

Lending from Commercial Banks

Each of the three main elements of central bank monetary policy serves to increase or decrease liquidity in the economy. The most common policy -- interest rate policy -- was utilized by the Federal Reserve at the outset of the recession. This pushed interest rates up against the zero bound. While this created a stock of very affordable money, it was insufficient to pull the economy out of the recession and effectively took interest rates off the table as a monetary policy lever. This leaves reserve requirements and quantitative easing as mechanisms for implementing expansionary monetary policy.

The quantitative easing policy sees the central bank buy bonds from intermediaries in the banking system. Money therefore enters the system, increasing bank liquidity. This practice should spur greater lending on the part of banks, which in turn would increase the amount of money for companies and consumers. Interest rates are already low, so the increased liquidity should in theory spur economic growth. In the current situation, there is an important risk to consider -- that the current economic climate is the result of a demand shock rather than a supply shock. The initial recession may have been the result of a supply-side shock -- the credit crunch -- but earlier monetary policy may have effectively resolved that shock. It is possible that what remains is a demand shock where consumers are not spending, leaving businesses with unused capacity. This effectively discourages investment, no matter how cheap the money, as businesses simply do not expand when they already have excess capacity. The possibility of a demand-side shock illustrates one of the significant risks of quantitative easing -- one that Ben Bernanke himself once alluded to in a 1988 paper -- that what intermediaries do is special and any rationing on their part may undue the desired impacts of monetary stimulus. Thus, the central bank can use a policy of quantitative easing on the expectation that it will improve liquidity in the economy, but the policy is risky in part because rationing on the part of financial intermediaries -- rather than liquidity -- is at the core of the economic stagnation.

If it is assumed that there are liquidity issues in the economy that are stalling the recovery, then the quantitative easing policy is a valuable tool. The United States Chamber of Commerce (2010) argues that by improving small business access to capital, more jobs can be created. Even if there is a demand-side shock that is inhibiting investment, quantitative easing's impact on the value of the dollar could help to stimulate small businesses that are active in export markets. Bean (2010) further argues that the purpose of quantitative easing is partly to ensure that both businesses and consumers have access to credit when they need it -- that a recovery is not stalled by poor access to credit. This line of thinking underlies the decision by the Federal Reserve to spread out its quantitative easing and why the Bank of England (2010) argues that a transparency is critical to the success of any quantitative easing policy.

The arguments made by both the Bank of England and the Federal Reserve highlight another of the important considerations with respect to the use of quantitative easing -- the policy is partly about impacting the expectations that the market has with respect to the future availability of credit. A QE policy, therefore, not only serves to inject capital into the economy but to send a signal that the central bank intends to continue to inject capital, thereby shepherding the economy out of the recession and ensuring no relapse occurs. Ugai (2007) further argues that quantitative easing creates the expectation of inflation. This creates demand in the economy for spending today before rates rise, and that demand takes advantage of the capital that has newly been injected into the economy. Ultimately, it is the expectation of inflation that brings interest rates away from the zero bound. Such a move has long-run risks related to inflation and the timing of rate decreases, but it also restores the ability of the central bank to use its most conventional monetary policy tool -- interest rates -- something it cannot do when nominal rates are near zero.

Job Creation

Bernanke & Reinhard (2004) argued that recessions typically constitute an adverse feedback loop in which economic weakness and financial stress are mutually reinforcing. Applied to the recent U.S. recession, the bursting of the housing bubble and subsequent credit crunch contributed to the creation of this type of feedback loop. Without access to capital from the banking system, businesses began to undertake contractionary activity. Anecdotal evidence at the time suggested that companies were unable to acquire the credit they needed to expand, and this lead directly to economic contraction. With contraction underway, unemployment began to rise and the demand shock was initiated. It was in this manner that the original feedback loop was created. The implication of Bernanke and Reinhart's assessment is that another shock is required to end the reinforcing feedback loop and turn the economy back in the right direction. Injecting money into the financial system would have the effect of spurring demand among consumers and businesses. Over time, this demand would… [END OF PREVIEW] . . . READ MORE

Two Ordering Options:

Which Option Should I Choose?
1.  Buy full paper (12 pages)Download Microsoft Word File

Download the perfectly formatted MS Word file!

- or -

2.  Write a NEW paper for me!✍🏻

We'll follow your exact instructions!
Chat with the writer 24/7.

Is Quantitative Easing a Suitable Policy? Research Paper

Computer Viruses: A Quantitative Analysis of User Term Paper

Surveillance and Data Sources Thesis

Reference Models in the Electronic Library Article Critique

Nursing Researchers This Is a Pilot Study Term Paper

View 200+ other related papers  >>

How to Cite "Quantitative Easing" Research Paper in a Bibliography:

APA Style

Quantitative Easing.  (2011, March 26).  Retrieved March 28, 2020, from https://www.essaytown.com/subjects/paper/quantitative-easing/7309

MLA Format

"Quantitative Easing."  26 March 2011.  Web.  28 March 2020. <https://www.essaytown.com/subjects/paper/quantitative-easing/7309>.

Chicago Style

"Quantitative Easing."  Essaytown.com.  March 26, 2011.  Accessed March 28, 2020.