Quantitative easing
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The term quantitative easing (QE) describes a monetary policy used by central banks to increase the supply of money by increasing the excess reserves of the banking system. This policy is usually invoked when the normal methods to control the money supply have failed, i.e the bank interest rate, discount rate and/or interbank interest rate are either at, or close to, zero.
A central bank implements QE by first crediting its own account with money it creates ex nihilo ("out of nothing").[1] It then purchases financial assets, including government bonds, agency debt, mortgage-backed securities and corporate bonds, from banks and other financial institutions in a process referred to as open market operations. The purchases, by way of account deposits, give banks the excess reserves required for them to create new money, and thus hopefully induce a stimulation of the economy, by the process of deposit multiplication from increased lending in the fractional reserve banking system.
Risks include the policy being more effective than intended, spurring hyperinflation, or the risk of not being effective enough, if banks opt simply to sit on the additional cash in order to increase their capital reserves in a climate of increasing defaults in their present loan portfolio.[1]
"Quantitative" refers to the fact that a specific quantity of money is being created; "easing" refers to reducing the pressure on banks.[2] However, another explanation is that the name comes from the Japanese-language expression for "stimulatory monetary policy", which uses the term "easing".[3] Quantitative easing is sometimes colloquially described as "printing money" although in reality the money is simply created by electronically adding a number to an account. Examples of economies where this policy has been used include Japan during the early 2000s, and the United States, the United Kingdom and the Eurozone during the global financial crisis of 2008–the present, since the programme is suitable for economies where the bank interest rate, discount rate and/or interbank interest rate are either at, or close to, zero.
Contents [hide]
1 Concept
2 History
3 Risks
4 Origin
5 Comparison with other instruments
5.1 Qualitative easing
5.2 Credit easing
6 See also
7 References
8 External links
[edit] Concept
Ordinarily, the central bank uses its control of interest rates, or sometimes reserve requirements, to indirectly influence the supply of money.[1] In some situations, such as very low inflation or deflation, setting a low interest rate is not enough to maintain the level of money supply desired by the central bank, and so quantitative easing is employed to further boost the amount of money in the financial system.[1] This is often considered a "last resort" to increase the money supply.[4][5] The first step is for the bank to create more money ex nihilo ("out of nothing") by crediting its own account. It can then use these funds to buy investments like government bonds from financial firms such as banks, insurance companies and pension funds,[1] in a process known as "monetising the debt".
For example, in introducing its QE programme, the Bank of England bought gilts from financial institutions, along with a smaller amount of relatively high-quality debt issued by private companies.[6] The banks, insurance companies and pension funds can then use the money they have received for lending or even to buy back more bonds from the bank. The central bank can also lend the new money to private banks or buy assets from banks in exchange for currency.[citation needed] These have the effect of depressing interest yields on government bonds and similar investments, making it cheaper for business to raise capital.[7] Another side effect is that investors will switch to other investments, such as shares, boosting their price and thus creating the illusion of increasing wealth in the economy.[6] QE can reduce interbank overnight interest rates, and thereby encourage banks to loan money to higher interest-paying and financially weaker bodies.
More specifically, the lending undertaken by commercial banks is subject to fractional-reserve banking: they are subject to a regulatory reserve requirement, which requires them to keep a percentage of deposits in "reserve",[citation needed]: these can only be used to settle transactions between them and the central bank.[7] The remainder, called "excess reserves", can (but does not have to be) be used as a basis for lending. When, under QE, a central bank buys from an institution, the institution's bank account is credited directly and their bank gains reserves.[6] The increase in deposits from the quantitative easing process causes an excess in reserves and private banks can then, if they wish, create even more new money out of "thin air" by increasing debt (lending) through a process known as deposit multiplication and thus increase the country's money supply. The reserve requirement limits the amount of new money. For example a 10% reserve requirement means that for every $10,000 created by quantitative easing the total new money created is potentially $100,000. The US Federal Reserve's now out-of-print booklet Modern Money Mechanics explains the process.
A state must be in control of its own currency and monetary policy if it is to unilaterally employ quantitative easing. Countries in the eurozone (for example) cannot unilaterally use this policy tool, but must rely on the European Central Bank to implement it.[citation needed] There may also be other policy considerations. For example, under Article 123 of the Treaty on the Functioning of the European Union[7] and later the Maastricht Treaty, EU member states are not allowed to finance their public deficits (debts) by simply printing the money required to fill the hole, as happened, for example, in Weimar Germany and more recently in Zimbabwe.[1] Banks using QE, such as the Bank of England, have argued that they are increasing the supply of money not to fund government debt but to prevent deflation, and will choose the financial products they buy accordingly, for example, by buying government bonds not straight from the government, but in secondary markets.[1][7]
[edit] History
Quantitative easing was used unsuccessfully[8] by the Bank of Japan (BOJ) to fight domestic deflation in the early 2000s.[9] During the global financial crisis of 2008–the present, policies announced by the US Federal Reserve under Ben Bernanke to counter the effects of the crisis are a form of quantitative easing. Its balance sheet expanded dramatically by adding new assets and new liabilities without "sterilizing" these by corresponding subtractions. In the same period the United Kingdom used quantitative easing as an additional arm of its monetary policy in order to alleviate its financial crisis.[10][11][12]
The European Central Bank (ECB) has used 12-month long-term refinancing operations (a form of quantitative easing without referring to it as such) through a process of expanding the assets that banks can use as collateral that can be posted to the ECB in return for Euros. This process has led to bonds being "structured for the ECB"[13]. By comparison the other central banks were very restrictive in terms of the collateral they accept: the US Federal Reserve used to accept primarily treasuries (in the first half of 2009 it bought almost any relatively safe dollar-denominated securities); the Bank of England applied a large haircut.
In Japan's case, the BOJ had been maintaining short-term interest rates at close to their minimum attainable zero values since 1999. With quantitative easing, it flooded commercial banks with excess liquidity to promote private lending, leaving them with large stocks of excess reserves, and therefore little risk of a liquidity shortage.[14] The BOJ accomplished this by buying more government bonds than would be required to set the interest rate to zero. It also bought asset-backed securities and equities, and extended the terms of its commercial paper purchasing operation.[15]
[edit] Risks
Quantitative easing is seen as a risky strategy that could trigger higher inflation than desired or even hyperinflation if it is improperly used and too much money is created.
Quantitative easing runs the risk of going too far. An increase in money supply to a system has an inflationary effect by diluting the value of a unit of currency. People who have saved money will find it is devalued by inflation; this combined with the associated low interest rates will put people who rely on their savings in difficulty. If devaluation of a currency is seen externally to the country it can affect the international credit rating of the country which in turn can lower the likelihood of foreign investment. Like old-fashioned money printing, Zimbabwe suffered an extreme case of a process that has the same risks as quantitative easing, printing money, making its currency virtually worthless.[1]
[edit] Origin
The original Japanese expression for "quantitative easing" (量的金融緩和, ryōteki kin'yū kanwa), was used for the first time by a Central Bank in the Bank of Japan’s publications. The Bank of Japan has claimed that the central bank adopted a policy with this name on 19 March 2001.[16] However, the Bank of Japan's official monetary policy announcement of this date does not make any use of this expression (or any phrase using "quantitative") in either the Japanese original statement or its English translation.[17] Indeed, the Bank of Japan had for years, and in an article published in February 2001 had claimed that "quantitative easing … is not effective" and rejected its use for monetary policy.[18] Speeches by the Bank of Japan leadership in 2001 gradually, and ex post, hardened the subsequent official Bank of Japan stance that the policy adopted by the Bank of Japan on March 19, 2001 was in fact quantitative easing. This became the established official view, especially after Toshihiko Fukui was appointed governor in February 2003. The use by the Bank of Japan is not the origin of the term "quantitative easing" or its Japanese original (ryoteki kinyu kanwa). This expression had been used since the mid-1990s by critics of the Bank of Japan and its monetary policy.
The earliest written record of the phrase and concept of "quantitative easing" has been attributed to the economist Dr Richard Werner, Professor of International Banking at the School of Management, University of Southampton (UK). At the time working as chief economist of Jardine Fleming Securities (Asia) Ltd in Tokyo, and noted for his 1991 warning of the coming collapse of the Japanese banking system and economy (reference: Richard A. Werner, 1991, The Great Yen Illusion: Japanese foreign investment and the role of land related credit creation, Oxford Institute of Economics and Statistics Discussion Paper Series no. 129), he coined the expression in an article published on September 2, 1995 in the Nihon Keizai Shinbun (Nikkei).[19]
According to its author, he used this phrase in order to propose a new form of monetary stimulation policy by the central bank that relied neither on interest rate reductions (which Werner claimed in his Nikkei article would be ineffective) nor on the conventional monetarist policy prescription of expanding the money supply (e.g. through "printing money", expanding high powered money, expanding bank reserves or boosting deposit aggregates such as M2+CD—all of which Werner also claimed would be ineffective).[3] Instead, Werner argued, it was necessary and sufficient for an economic recovery to boost ‘credit creation’, through a number of measures.[19] He estimated at the time that the incipient bad debt problem of the Japanese system (i.e. including future bad debts) amounted to about ¥100 trillion, or 20% of annual Japanese GDP, and that this had increased banks’ risk aversion. The subsequent slowdown in bank credit extension was the major problem, because commercial banks are the main producers of the money supply, through the process of credit creation. He thus recommended as a solution policies such as direct purchases of non-performing assets from the banks by the central bank, direct lending to companies and the government by the central bank, purchases of commercial paper (CP) and other debt, as well as equity instruments from companies by the central bank, as well as stopping the issuance of government bonds to fund the public sector borrowing requirement and instead having the government borrow directly from banks through a standard loan contract.[20] All of these, Werner claimed, would stimulate credit creation and hence boost the economy. Many of these policies have recently been adopted by the US Federal Reserve under Chairman Bernanke, who was familiar with the debate on Japanese monetary policy, under the expression of "credit easing" (see below).
However, while Werner used and explained the concept of credit creation in his article, he chose not to use it in the article’s title, as too few readers would be familiar with it and alternative expressions were associated with flawed or failed policy prescriptions. Werner preferred to coin a new phrase.[3] In his subsequent writings, including his bestselling book on the Bank of Japan (Princes of the Yen, M. E. Sharpe, and his 2005 book New Paradigm in Macroeconomics: Solving the Riddle of Japanese Macroeconomic Performance, Palgrave Macmillan), Werner argues that the Bank of Japan’s usage of his expression ‘quantitative easing’ may be misunderstood. While suggesting it was adopting the policy suggested by a leading critic, the Bank of Japan implemented the standard monetarist expansion of bank reserves and high powered money, which Werner had predicted would fail.[17] It is not obvious why the Bank of Japan chose to use Mr Werner’s expression, and not the already existing and widely used expressions ‘expansion of high powered money’, ‘expansion of bank reserves’ or, simply, ‘money supply expansion’, which more accurately describe its adopted policy at the time.[21]
[edit] Comparison with other instruments
[edit] Qualitative easing
Willem Buiter has proposed a terminology to distinguish quantitative easing, or an expansion of a central bank's balance sheet, from what he terms qualitative easing, or the process of a central bank adding riskier assets onto its balance sheet:
Quantitative easing is an increase in the size of the balance sheet of the central bank through an increase it is [sic] monetary liabilities (base money), holding constant the composition of its assets. Asset composition can be defined as the proportional shares of the different financial instruments held by the central bank in the total value of its assets. An almost equivalent definition would be that quantitative easing is an increase in the size of the balance sheet of the central bank through an increase in its monetary liabilities that holds constant the (average) liquidity and riskiness of its asset portfolio.
Qualitative easing is a shift in the composition of the assets of the central bank towards less liquid and riskier assets, holding constant the size of the balance sheet (and the official policy rate and the rest of the list of usual suspects). The less liquid and more risky assets can be private securities as well as sovereign or sovereign-guaranteed instruments. All forms of risk, including credit risk (default risk) are included.[22]
[edit] Credit easing
In introducing the Federal Reserve's response to the 2008-9 financial crisis, Fed Chairman Ben Bernanke was keen to distance the new programme, which he termed "credit easing" from Japanese-style quantitative easing. In his speech, he announced:
“ Our approach—which could be described as "credit easing"—resembles quantitative easing in one respect: It involves an expansion of the central bank's balance sheet. However, in a pure QE regime, the focus of policy is the quantity of bank reserves, which are liabilities of the central bank; the composition of loans and securities on the asset side of the central bank's balance sheet is incidental. Indeed, although the Bank of Japan's policy approach during the QE period was quite multifaceted, the overall stance of its policy was gauged primarily in terms of its target for bank reserves. In contrast, the Federal Reserve's credit easing approach focuses on the mix of loans and securities that it holds and on how this composition of assets affects credit conditions for households and businesses.[23]
Complementary currency
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Not to be confused with private currency or alternative currency .
This article may require cleanup to meet Wikipedia's quality standards. Please improve this article if you can. The talk page may contain suggestions. (May 2008)
Complementary currency (CC) is a currency which is meant to be used as a complement to a national currency.[1] Complementary currency is sometimes referred to as complementary community currency (CCC) or as community currency. The term local currency, describing a complementary currency which is limited to a single locality, is sometimes used interchangeably with complementary currency. There are, however, some complementary currencies which are regional or global, such as the WIR or Friendly Favors, or the proposed global currency terra.[2]
Contents [hide]
1 Types of complementary currencies
2 Purposes
3 Complementary Currencies
4 Example of a fully funded CC
5 Major CC Activists
6 See also
7 External links
8 References
[edit] Types of complementary currencies
Complementary currencies describe a wide group of currencies or scrips designed to be used in combination with standard currencies or other complementary currencies. They can be valued and exchanged in relationship to national currencies but also function as media of exchange on their own. Complementary currencies lie outside the nationally defined legal realm of Legal tender and are not used as such. Rate of exchange, scope of circulation and use in combination with other currencies differs greatly between complementary currency systems, as is the case with national currency systems.
Some complementary currencies incorporate value scales based on time or the backing of real resources (gold, oil, services, etc). A Time-based currency is valued by the time required to perform a service in hours, notwithstanding the potential market value of the service.
Some complementary currencies take advantage of demurrage fees, an intentional devaluation of the currency over time, like negative interest. This stimulates market exchanges in the devaluating currency, propagates new participation in the currency system and forces the storage of wealth (hoarding) ability usually reserved for currency into more permanent and better value holding tools like (property, improvement, education, technology, health, equity securities, etc) all of which are sheltered from the currency based demurrage fees.
Other experimental complementary currencies use high interest fees to promote heavy competition between participants, and the removal of wealth from long term wealth holding structures (natural/material wealth, property, etc) to aid in the process of rapid industriaization, mass production, automation and competitive innovation.[citation needed]
Monetary speculation and gambling are usually outside the design parameters of complementary currencies. Complementary currencies are often intentionally restricted in their regional spread, time of validity or sector of use and may require a membership of participating individuals or points of acceptance.
[edit] Purposes
Complementary currencies are often designed intentionally to address specific issues or problems.[3] Most complementary currencies have multiple purposes and/or are intended to address multiple issues. They are very useful for communities that do not have access to financial capital, and can be useful for adjusting peoples' spending behavior.[4] The 2006 Annual Report of the Worldwide Database of Complementary Currency Systems presented a survey of 150 complementary currency systems in which 94 respondents said that "all reasons" were selected, among cooperation, micro/small/medium enterprise development, activating the local market, reducing the need for national currency, and community development.[5]
In the current economic climate, some local money projects can also be promoted as
low carbon, by encouraging localisation of trade and relationships
lifeboat currencies
encouraging use of under-used resources
recognising the informal economy
[edit] Complementary Currencies
Beginning in the 1960s, the first advocates of complementary currencies, especially in Canada, did not think of CC as working contra to our national currencies.[citation needed] This is why certain leaders of this movement were careful to use the term 'complementary'. They used it to emphasize the importance of working in cooperation with governments and the tax system, businesses, unions, associations, charities, the banks and all forms of democratic capitalism—as partners in the above-ground economy.
[edit] Example of a fully funded CC
For example, The Toronto dollar system, is a system which is fully funded by Canadian dollars. In other words, the system is backed by Canadian dollars. Participating merchants are free to exchange the Toronto dollars for Canadian dollars. While the system will work better when more and more of the CC is kept in circulation, no one needs to feel trapped by the system.
In addition to being supported by any number of social activists, including philosophers, clergy, artists, etc., it is fully supported by a growing number of political leaders, past and present, including, over the years, several mayors of Toronto.
[edit] Major CC Activists
Some major CC activists are Professor Bernard Lietaer [1] and British enconomist, Hazel Henderson, [2]. Lietaer has argued that the world's national currencies are inadequate for the world's business needs, citing how 87 countries have experienced major currency crashes over a 20 year period, and arguing for complementary currencies as a way to protect against these problems.[6] Lietaer has also spoken at an IRTA conference about barter.[7]
