Sunday, 8 February 2015

Pros and Cons #2: Quantitative Easing

One of the most prominent national economic policies that has emerged in the 21st century is Quantitative Easing. A practice originating from the Bank of Japan to fight falling spending that was causing damaging deflation in the 1990s, it consists of the purchasing of financial assets (intangible assets, such as stocks and bonds as opposed to properties) from commercial banks by a country's central banking authority. The money these banks gain, theoretically, will allow them to take increased risks in lending more money to individuals and businesses, who, in spending and investing the loaned money, will help spur economic growth. Essentially, the central bank is pumping extra money into the economy- but not, as popular belief goes, in the form of masses of newly printed cash, but rather electronic money that, sometime down the road, becomes part of the national flow of money.

QE is something of a last resort for a faltering economy. Usually interest rates are manipulated; in times of deflation, when more consumer spending is needed, interest rates are lowered, which makes borrowing money cheaper and thus more popular. QE comes in when interest rates head closer towards 0%, and cannot be lowered further.

So, for our second instalment of Pros and Cons, let's look at Quantitative Easing.

PRO - Economic Stimulus
More lending by the banks usually translates into higher spending by businesses. Whether it is on new facilities such as factories or retail stores, or office renovation, extra money is pumped into the economy. When deflation is becoming an issue, spending is low and business as a result is not good for most- however making money more available will mean businesses are more likely to spend more money.
Employment is a particular focal point for QE- hopes are that, being able to lend more money, businesses will invest in more jobs. With more people in work, consumer spending is likely to increase, further revitalising the economy.
It's a stimulus, like a bump-start for a car; the hope is that putting the economy back into motion, even by money created out of thin air, will allow it to recover itself and eventually become independent of such stimulus.

CON - Misuse
However, a dangerous possibility with regards to monetary stimulus such as QE is that the money will be misused; giving extra money to banks has not been such a popular policy in recent times, and perhaps rightly so. Despite the faltering global economy of the past decades, bankers' bonuses and bank profits as a whole have been booming- and there is certainly a strong case for arguing that QE, as well as the bailouts of 2007/08 have only contributed to this.
Companies who benefit from the greater lending power are also not guaranteed to use the money how theory suggests. Executive pay has been just as much an issue as that of bankers, and while it may not be considered a misuse, much of the extra money may go into investments abroad, such it into offshore tax schemes or outsourced employment- these may result in increased profits for the business but not the overall economic stimulus QE is designed to provide to a nation's economy.

PRO - Combat Deflation
The problem of deflation (which you can read more about here) is, in a nutshell, caused by a shortage of money supply in circulation. This means everyones' purses are tightened and thus spending in the economy falls with wages, and subsequently prices fall also. QE is primarily designed to act against falling prices and wages- by increasing the amount of money in the economy, the hope is that spending will recover and prevent spiralling deflation.

CON - Inflation
On the other side of the coin, there is a fear that monetary programs such as Quantitative Easing could tilt the economy the other way. If too much money floods the economy, its worth will fall too much, resulting in inflation, the drastic rise in prices. While the central financial authority can control how much money can enter the economy, it becomes very difficult once it becomes part of it- it's like adding a selection of straws of hay to a haystack and trying to pick out those exact straws after it's all been mixed up. While many claim inflation is a more desirable alternative to deflation, and central banks have of course made reassurances that inflation could be controlled at the end of a course of QE, the world's inexperience of whole QE cycles mean the inflationary potential of the stimulus remains a grey area.

PRO/CON - Alternative to Austerity
This is a more subjective pro; QE is an alternative to austerity with regards to dealing with deficit and growth issues. While a policy of austerity would involve cutting of government spending, balancing the books by cutting spending, the expansionist QE policy is designed more to deal with the deficit by boosting productivity, though at the cost of maintaining spending.
Austerity would be arguably a more risk-free way to deal with the deficits, but its negative effects on government services such as social welfare and public services such as education and health. On the other hand QE would maintain such services, and in many cases would lead to improvements in infrastructure as spending increases as a result of the more accessible money. However some doubt that spending extra to reduce the deficit is the optimal solution, due to risks it presents if the spending does not produce results. This is particularly an argument for those who believe in small government, that the private entities are more successful and efficient participants in the economy than the state.

Mohammad Lone Editor