Interest rates have been cut again - to a record low of 1.5 percent. As they get ever closer to zero, the impact of rate cuts will become more and more limited. So what can central banks do to ease the economic pain?
“Quantitative easing”, or what non-economists call “turning on the printing press” is one of the options.
Here is our guide to how it works and which countries have used it:
WHAT IS QUANTITATIVE EASING?
– Quantitative easing refers to ways of boosting economic growth after traditional monetary policy tools, such as interest rate targets, have been exhausted.
– Central banks flood the banking system with masses of money, more than is needed to keep official interest rates at zero or a low rate, to shore up financial systems and promote lending. They usually do this by buying up large quantities of assets from banks.
WHO HAS USED IT?
* JAPAN:
– The BOJ adopted quantitative easing, going beyond keeping interest rates at zero, in March 2001 after the economy was hit by the bursting dot-com bubble and remained stuck in a battle with deflation.
– Many experts, including some BOJ policymakers, were sceptical whether the policy had any direct effect in reviving the economy, but most agreed it helped limit deflation and avert a more serious banking crisis.
– The extra fund cushion meant banks, burdened with massive nonperforming loans, avoided a liquidity crunch and were able to take bolder steps in cleaning up their loan portfolios.
– Instead of a traditional policy of raising or cutting short-term rates, the BOJ set a target for the amount of money it force-fed into the banking system. The funds were injected mainly through the BOJ’s purchases of government and commercial securities from banks. The policy ended in 2006.
WHO IS USING IT?
* THE FED:
– Economists agree the U.S. Federal Reserve has adopted a form of quantitative easing in its efforts to stabilise the financial system and help the economy, though in a different way from what the BOJ conducted.
– The Fed cut the benchmark federal funds rate target to a range of zero to 0.25 percent, saying it would help markets and stimulate the economy by keeping its balance sheet at a high level.
– The Fed has committed to purchasing large amounts of mortgage-related debt to help the housing market, and it is considering outright purchases of government bonds.
– Since the bankruptcy of Lehman Brothers in September, the Fed’s array of measures to shore up the financial sector has already caused its balance sheet to more than double in size to a record level above $2 trillion.
– The Fed said that its dramatic policy action last week did not signal increased concern about deflation but a determination to improve lending conditions by lowering mortgage rates and other important financial rates.
WHO MAY USE IT?
* BOE:
– Bank of England policymaker David Blanchflower said last month that monetary policymakers would be right to consider using extraordinary measures, including quantitative easing, to boost the economy and prevent a deflationary spiral.
* BOJ:
– If the global recession deepens, the BOJ may return to quantitative easing early next year. Naoki Iizuka, senior economist at Mizuho Securities, said the BOJ could resort to cutting Japanese rates to zero as early as January to contain the slump. Some analysts see the central bank going even further by reverting to quantitative easing.
– Using this policy could be hard to swallow for BOJ Governor Masaaki Shirakawa who, as a central bank bureaucrat, was involved in crafting the policy and has warned that keeping rates too low would distort money market functions.
– Senior BOJ officials have said the bank was not ruling out any policy options as the economy, already in recession, faces the risk of suffering its longest contraction on record.
– Shirakawa told parliament last month quantitative easing had a certain effect in stabilising the financial system, adding that he was examining the effects and side-effects of the policy.
– Like the Fed, the BOJ is trying to target troubled markets that are affecting the economy, such as the commercial paper market in which companies raise short-term financing. The BOJ said last week it would buy commercial paper outright and would boost the amount of its monthly government bond purchases.
(Guide compiled by David Cutler and Jijo Jacob)
Bankers, politicians and regulators have taken their share of the blame for the credit crisis.
