October 5, 2014 7:46 pm
Monetary policy: An unconventional tool
The Fed’s quantitative easing raises questions about whether it has worked and its legacy
Since September 2008, the balance sheet of the US Federal Reserve has expanded by $3.5tn to close to 25 per cent of US gross domestic product. This month, the Fed is expected to end its experiments with policies, particularly “quantitative easing”, that have had this result. QE is contentious. So what have the Fed and other central banks done? Has it succeeded? What problems does it bequeath?
QE involves the creation of central bank money on a large scale. That makes it “quantitative”. It is one of a family of unconventional policies employed in the aftermath of a crisis that damaged the financial system and caused a deep recession. As the International Monetary Fund has noted, “central banks in advanced economies responded with unconventional tools to address two broad objectives: first, to restore the proper functioning of financial markets and intermediation, and second to provide further monetary policy accommodation . . . The two objectives, while conceptually distinct, are closely related.”
The Fed had to be particularly imaginative because the US financial system was more complex and more dependent on “shadow banking” – intermediation outside the banking system – than were those of other advanced economies. Liquidity provision was extended to non-bank entities, for example, such as securities firms.
Such large-scale asset purchases were an element in a set of policies aimed at restoring a degree of normality to financial markets and financial institutions. This has been called “credit easing”.
Asset purchases are also designed to reinforce monetary policy. The justification has been the reduction of conventional central bank intervention rates to the “zero lower bound”. That is where the rates of the Fed and Bank of England have languished since 2009. It is where the European Central Bank has reluctantly placed its rates. The Bank of Japan’s rates have been near zero for two decades. Central bank asset purchases are a way to make monetary policy effective when short-term rates are already at the zero lower bound. Such QE is held to affect monetary conditions via a “scarcity channel”, a “duration channel” and a “signalling channel”.
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