Finance

Quantitative easing

What is quantitative easing
Usually, central banks try to raise the amount of lending and activity in the economy indirectly, by cutting interest rates.

Lower interest rates encourage people to spend, not save. But when interest rates can go no lower, a central banks only option is to pump money into the economy directly. That is quantitative easing (QE).

The way the central bank does this is by buying assets - usually financial assets such as government and corporate bonds - using money it has simply created out of thin air.

The institutions selling those assets (either commercial banks or other financial businesses such as insurance companies) will then have new money in their accounts, which then boosts the money supply.

QE had never been tried before in the UK.

Research Paper Flow
What is quantitative easing How does the policy works Expected results
How does the policy works Expected results

Problems of QE
Reception of QE on Banks (insert banks as major players) (how each respond to QE
Study briefs on banks decision to apply the policy, its journal entry input in the balance sheet
Study briefs on banks decision on not applying the policy, and their alternatives.
Examples of commercial banks outside UK (Japan, and find a local bank) regarding the application of QE, and the success rate (can input oecd report)

Inflation as a major cost drive
Is it effective
1. Is zero Inflation necessary What is the right inflation rate then
2. Public perception of the governments implementation of the policy.
3. Detecting the inception factors of a financial bubble. And is it present should a monetary policy takes place
4. The correlation of printing money to inflation.
Is a stimulus package or a QE a quick band-aid to ugly financial forecast ahead
In a February 5 QA article of the BBC, it has been reported that QE, or quantitative easing, has never been tried before in the UK.

The quantitative easing policy has, albeit, been a successful monetary policy introduced in Japan last 2001. The policy targets reserves, or the banks current account balances at the central bank, while keeping short  term interest rates at zero (OECD, year, p. 45). The results reflected on the countrys economy through the following observations promoted financial-sector stability through the provision of ample liquidity to banks helps keep long-term interest rates at a lower level (policy duration effect)
pumped up the monetary base to higher levels (GDP rate was 22)

The monetary policy further stabilized inflation, as measured by the core CPI, by keeping it to zero or above.

How quantitative easing and stimulus package are similar
In simpler terms, Quantitative easing is a monetary policy that increases the money supply through the creation of money.

The Scenario
1. The Central Bank creates money electronically. (This is similar effect to printing money, except they are increasing bank reserves which dont need to be printed in the form of cash)
2. With this increase in Bank reserves, the Central Bank is using them to buy various securities. These include government bond and corporate bonds.

Buying these securities achieves two things
Banks sell assets for cash. Therefore they see an increase in their liquidity (cash reserves). In theory the bank will then be more willing to lend to customers. This lending will be important for increasing investment and consumer spending.

Buying assets reduces their interest rate. Lower interest rates on these securities may also encourage banks to lend rather than keep securities which are paying low interest.

Problems to encounter in QE
1. Inflation. When economy recovers it might be difficult to take out the excess money supply causing uncontrollable inflation.
2. Investors could lose confidence in economy due to risk of inflation
3. Danger of bond bubble. Bonds and gilts will rise in price encouraging investors to buy and interest rates to fall. This could cause a bubble in the price of gilts which could collapse at a later stage causing long term interest rates to rise at an early stage in the business cycle.
4. Could cause lower value of Pound - Pound slumps on QE fears
5. Problem of printing money
6. Printing money and inflation

The Bank of England explains the benefits of a low inflation, and keeping it stable within minimum range

Unstable rates of inflation are costly to households and companies. They make it hard to see how prices of individual goods are changing compared with one another. And uncertainty over future prices makes it more difficult to enter into long-term contracts.

Why inflation is an issue
Hellerstein (Winter 1997) notes that inflation is a common misnomer that generates a lot of public tension regarding a regions economy. Perhaps the greatest reminder of what inflation has done was the 1970 insurgence in the US economy. The cost of living was not highly anticipated by most people who had set up long-term investment funds.

A much more underlying issue is the use of the inflation phenomenon to account for state and government decisions that most likely will not sit well on the public. The unsettlement on this theory was supported by economists Peter Diamond, Eldar Shafir, and Amos Tversky that people mostly consider nominal earnings rather than real earnings (qtd in Hellerstein, Winter 1997).

Bank of England uses Credit market interventions as a debit journal entry, and is treated as an asset.

In another BBC article dated February 4 of this year, The Bank of England had decided to postpone quantitative easing. Inflation is termed by economists as the rate of which the general level of prices for goods and services is rising, and that in an adverse effect, purchase power is falling (Investopedia).

Banks and their stand on inflation
1. Bank of England
The financial institution has been founded in 1694, and has been nationalized on the 1st of March 1946. They have gained their independence in 1997, and has committed itself to promote and maintain monetary and financial stability as its contribution to a healthy economy (Bank of England 2010).

2. RBS
It has sought state and international goals to be one of the formidable financial institutions, with over 280 years of financial services experience starting 1727.

In a public statement echoed in various media, RBS has expressed gratitude of the governments extension of quantitative easing

We are in a privileged position to have the support of the UK taxpayer while we restructure. That privilege exists because of our central role in the UK economy and society. That role brings responsibilities for us to change both the business we do and the way we do business which we are already doing.

Our strategic plans will take three to five years to achieve, given the scale of the task and the economic conditions we face. However, we expect to make purposeful progress each and every year. We have already begun a programme of reducing our costs and aligning the Banks activities to the reality of our situation.

Initial details of the plan

3. Lloyds Banking Group
Lloyds was initially named Lloyds TBS Group on the 19th of January last year, following a revamp of the financial institution with the acquisition of HBOS. They are currently the largest retail bank in the UK.

4. Barclays
Established by John Freame and Thomas Gould in 1690, Barclays emerged as a global financial services provider that engages in retail and commercial banking, credit cards, investment banking, wealth management and investment management services all over the world (Barclays).

It is to note that Barclays acquired Lehman Brothers (its North American investment banking and capital markets business) in 2008, and completes integration in 2009.

Is it effective
1. Is zero Inflation necessary What is the right inflation rate then
2. Public perception of the governments implementation of the policy.
3. Detecting the inception factors of a financial bubble. And is it present should a monetary policy takes place
4. The correlation of printing money to inflation.