(The Straits Times; Review. Tuesday, November 23 2010. By Linda Lim:
Review Brief: On Quantitative Easing; Printing money to push spending)
What is the Fed and what does it do?
- central bank of US
- Responsible for money supply, monetary policy and financial system supervision
Why some Americans including the Tea Party activist oppose Fed?
- suspicious of Fed's independence from elected representatives; i.e. influenced by banks and other financial institutions
What is QE2 and why the Fed undertake it?
- "Quantitative Easing" (second package)
- involves phased purchase of an additional US$600bil of treasury bonds, with newly printed US dollars
- to boost purchasing power in the economy to stimulate C and I thus creating jobs
- recession cleared via monetary and fiscal policies, but unemployment remained high wile inflation lower than desired
- FP impossible due to fiscal debts therefore only further monetary stimulus left as an option to reduce unemployment.
- interest rates being near zero, increasing money supply (ex nihilo) to buy back government bonds is the one remaining policy tool. That means putting money into people's pocket to induce spending (positive wealth effect) will stimulate more spending, creating employment
So why oppose QE2?
- since monetary and fiscal policies have both failed in reducing unN, more will be similarly ineffective
- increasing money supply may raise inflation more than fed expects
- "cheap money" (comes easily and caused the crisis in the first place; think of the bubble to start off with)
may induce risky financial behaviour
Fed's reply
- will reverse bond buying if inflation picks up
- post crisis reforms has reduced market risk, as per previous stimulus
Why other countries object to QE2?
Germany:
- QE2 will weaken US$ because of an increase in supply and "dollar carry trade" (borrowing in depreciating low-interest dollars to invest in stronger or higher-interest currencies) will revive it.
- weak US$ will make it difficult for German to grow by exporting to the US or compete with US products in other countries
- post crisis Germany chose fiscal austerity, limits its domestic demand growth.
- other European countries also practicing fiscal auterity, meaning Germany cannot export to them.
Brazil:
- low i/r, depreciating dollar and weak growth makes investing in US unattractive.
- savers among other advanced countries are choosing to invest instead in fast growing emerging markets, like Brazil
- this flood in capital leads to appreciation of their currencies against the dollar, reducing export competitiveness
- also cause inflationary bubbles in stock, bonds and real estate which might deflate and cause capital exit
China:
- Yuan fixed to Dollars i.e. weak dollar leads to weakening of Yuan
- therefore China's export competitiveness may in fact improve against countries whose currencies floats and gain strength against dollars (yuan)
- China will need to prevent the excess dollar it earns from its persistent CA surplus from being converted into yuan and spend inside the economy to prevent inflation so as to maintain its exchange rates against the dollars
- does this by increasing dollar reserve by buying US treasuries that earn low interest return and are denominated into currency which will eventually depreciate against the yuan. Or issue bonds to "mop up" surplus dollars which are converted into yuan
- However, China still facing inflation and this poses threat to both export competitiveness and social stability
- therefore has tightened monetary policies by raising interest rates and increasing bank reserve requirements and impose restriction on property purchase, considering price controls on staples and earned that GDP grow must slow.
- China objects to QE2 because the resultant dollar depreciation will make the incremental Yuan appreciation it had planned less effective thus requiring faster and potentially more disruptive appreciation
- also, dollar depreciation will also reduce the value of China's massive accumulation of dollar denominated assets.
