When I was a child growing up, and I wanted the latest toy, I was always told that “money doesn’t grow on trees”. I would always respond “just go to the bank and get some more” which was met by a laugh, followed by a definite no.
If only I knew about Quantitative Easing as a child, I would have been justified by what I said (to an extent)!
Unless you have been living under a rock since the Financial Crisis of 2007, you will have heard of the term Quantitative Easing (QE) which represents an unconventional method of monetary policy.
What is Quantitative Easing?
QE involves the expansion of the monetary base in an economy usually through the purchase of assets such as sovereign bonds.
A few years ago, Mario Draghi (President of the ECB) did a u-turn on his previous statements that the Eurozone would never use Quantitative Easing, and announced a €60bn bond buying programme in the Eurozone which lasted until the end of last year.
The aim of the policy was to increase the ECB balance sheet by close to €1tn is to ease the deflationary fears of the Eurozone.
The ECB hoped that this would stimulate investment and consumption both domestically and from abroad, and put in close to $3tn in this four year period.
The investment aimed to reduce domestic interest rates increasing borrowing (due to increased liquidity availability), and through devaluation of the domestic currency making exports more competitive.
The existence of policies in specific ‘trouble’ nations are aimed at reducing wages and prices of consumables to a more acceptable level by pumping additional money into their economies.
As a result of this Quantitative Easing, the Eurozone successfully increased economic growth in the region, in addition to lifting wages and lending.
Despite this though, inflation was relatively unmoved, and interest rates have remained low which hurts the profitability of banks.
How does Quantitative Easing Work?
By creating new money (out of thin air – or electronically), a Central Bank can use it to buy assets from other banks such as government bonds.
By inflating the money base of an economy, you are effectively breaking down the real value of your total monetary base into a greater number of individual units (in this case: Euros).
As there are a greater number of monetary “units”, individuals and corporations all perceive a wealth increase which influences spending.
Over time, prices increase to adjust for this increase in the monetary base, which affects inflation.
Conventional Quantitative Easing is supposed to be followed by a subsequent bond sale, to reduce the monetary base, but this leads to the risk of growth slowdown, reduction in bank liquidity, and deflation.
What are the Downsides of Quantitative Easing?
For the average person in the Eurozone, printing money effectively reduced the real value of each euro that they earn or save (despite the nominal value remaining the same).
This was essentially a hidden tax created to draw wealth away from each individual and corporation operating in the Eurozone.
Using the value extracted from the current money supply, it then redistributed back to corporations looking to expand their businesses (hopefully filtering down to increased growth, and higher wages).
In reality, wages were quite ‘sticky’, and they didn’t move as freely despite price inflation increases.
This means that firms who benefited from cheap investment were not raising wages proportionately.
There is evidence in the UK that the last bout of Quantitative Easing actually increased the wealth inequality between the richest and poorest of our nation – the £375bn Quantitative Easing programme since early 2009 transferred 40% of the generated wealth to the richest 5% of households.
I would argue that QE is only beneficial to individuals and institutions if they are willing to accept more debt.
The Bank of England estimated that they £375bn Quantitative Easing policy had devalued British savings by £70bn, and yes this includes your pensions too!
If you are someone who has sticky wages (as your company refuses to increase your salary despite benefiting from cheaper borrowing rates, and payoffs from investment in new ventures), and inflation increases the prices of your typical household purchases; you will be worse off financially.
What are the Arguments FOR Quantitative Easing?
There is an argument that says that if Quantitative Easing is not used, there is a risk that companies could start to collapse.
Furthermore, banks would not be able to operate properly putting your savings at greater risk (the best of two bad choices).
However, if the outcome of Quantitative Easing policy is to increase the income equality gap, then surely it is an unproductive, hidden tax, and there must be a more effective way of kick-starting an economy.
If Quantitative Easing is to be used for redistribution of wealth into businesses through investment and consumption, and to devalue the domestic currency; perhaps it would be better to split the “printed” money equally between each adult in the economy, and given to them with the caveat that the money must be spent (rather than saved).
Money could be used to pay off existing debts reducing the monthly cost of outgoings (to hopefully stimulate future consumption).
Alternatively, if each adult has no debt, the money could be spent via consumption in businesses and institutions, providing the sort of boost to growth that Quantitative Easing aims to do.
This would stop banks from retaining the increase in wealth, and probably would increase net happiness of each individual in that economy.
The expansion of the monetary base would also devalue the domestic currency, leading to greater competitiveness of exports providing a further boost to the economy.
This would probably never happen, but on an aggregate level, I fail to see how this can be no better than Quantitative Easing now.