Now that the Fed has effectively reduced interest rates to zero, what are the new arrows in the Fed's quiver? One is quantitative easing, which was employed with limited success by the Bank of Japan during its deflationary cycle a few years ago. What is quantitative easing? In a short definition, it is lowering interest rates to near zero and flooding the financial system with excessive liquidity in an attempt to stimulate private lending. A better question is, does it work? The Bank of Japan's own assessment of its effectiveness was that "the possible stimulus obtained... was likely to be limited." Ouch!
Click here for an excellent primer on how quantitative easing is supposed to work.
Here is another excellent article on the subject. (I also suggest reading the reader comments. Some are quite insightful.)
Click here for an excellent primer on how quantitative easing is supposed to work.
Here is another excellent article on the subject. (I also suggest reading the reader comments. Some are quite insightful.)
From Wikipedia, the description of quantitative easing is thus:
"With quantitative easing, [the Bank of Japan] flooded commercial banks with excess liquidity to promote private lending, leaving them with large stocks of excess reserves, and therefore little risk of a liquidity shortage. The BOJ accomplished this by buying more government bonds than would be required to set the interest rate to zero. It also bought asset-backed securities, equities, and extended the terms of its commercial paper purchasing operation."
Now doesn't that sound just like what the Fed is doing now?
Unfortunately, quantitative easing didn't work very well, if at all, in Japan. Following the initiation of quantitative easing by the Bank of Japan in 1998, the stock market didn't bottom for 5 more years! Worse yet, real estate prices in Japan continue to fall nearly two decades later!
Unfortunately, quantitative easing didn't work very well, if at all, in Japan. Following the initiation of quantitative easing by the Bank of Japan in 1998, the stock market didn't bottom for 5 more years! Worse yet, real estate prices in Japan continue to fall nearly two decades later!
Thus, one must wonder why the Fed is using it now. It certainly has a pall of desperation about it. Is this all they have left to try? Recent Fed documents suggested that the Fed might soon begin to use it, although the Fed seems reluctant to call it that. The Fed says it is engaging other forms of stimulus also. But a spade is still a spade, even if you call it something else. If it walks like a duck and quacks like a duck... Perhaps the Fed has other forms or additional arrows still in mind? They'd better, because quantitative easing doesn't have a very good history of success!
