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Tuesday, September 6, 2016

Quantitative easing no longer the solution



While central banks in Europe and Japan set to expand quantitative-easing (QE) policy, it appears that the "magic" that QE once has is no longer working. The idea that QE could be used to stimulate slowing economies could really just be a myth now.


We have all seen how the US Federal Reserve has managed to persevere through the period of QE and Abenomics come after that...but the likelihood for us to see the QE magic work with both the central banks in Europe and Japan is low...things have changed.

An article written by Mark Gilbert on Bloomberg: The Quantitative Easing Experiment is Failing talks about the few areas that QE may have failed.

Inflation hasn't been at the European Central Bank's (ECB) 2 percent target since the start of 2013; it's been half that or less for the past two years. 

And here is what Mark said, "So I sympathize when ECB President Mario Draghi says he'll expand the use of non-conventional measures to avert the threat of deflation; but I worry that with no evidence that the patient is responding to treatment, increasing the dosage is pointless."

The author was increasingly more skeptical of what the QE could achieve. Textbook answer says that it should channel money into the economy via the banking system and Draghi has been firm in his decision to safeguard the euro and meet the ECB's targets. With the results not showing any significant improvement, it is no wonder that many more are disillusion with what QE could really do. 

EQUITY HAS BECOME TOO EXPENSIVE

One of the big change at the current environment was that the equity has become so expensive. This sort of negate the positive impact from the cheap loan. Anyone who have taken CFA examination or investment studies would have learned that weighted average cost of capital (WACC) consist of both debt and equity. 


"Corporates aren't feeling the financing benefits offered by the global fall in real long-term interest rates thanks to a historically-high equity risk premium — which, in simple terms, is the excess return the stock market is expected to earn over a perceived risk-free rate," Hans Lorenzen, a Citi credit analyst said.

To simply the argument, we have compiled a list of positives and negatives of QE:

Positives

1) It provides additional cash in the system when there is a need for it.

2) There is no cost to the government and the taxpayers.

3) Confidence in the system will increase.

4) Things could have been worse than what it is today without the QE earlier.

5) This is the only options left if the fiscal policy is limited.

Negatives

1) It is difficult to know exactly what happens to the money released into the system.

2) QE doesn't seem to boost confidence of late.

3) The risk is that the money keeps piling up in the banks balance sheet and never helps small businesses where it's needed.

4) A minority of economists, such as the former MPC committee member Andrew Sentance, believe it could feed inflation.


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