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Posts Tagged ‘money supply’

Active or passive QT? The Fed’s future approach to monetary policy

The US Federal Reserve, like many other central banks, engaged in massive quantitative easing in the wake of the financial crisis of 2007/8. Over three rounds, QE1, QE2 and QE3, it accumulated $4.5 trillion of assets – mainly government bonds and mortgage-backed securities (see chart below: click here for a PowerPoint). But, unlike its counterparts in the UK, the eurozone and Japan, it has long ceased its programme of asset purchases.. In October 2014, it announced that QE was at an end. All that would be done in future would be to replace existing holdings of assets as they matured, keeping total holdings roughly constant.

But now this policy is set to change. The Fed is about to embark on a programme of ‘quantitative tightening’, already being dubbed ‘QT’. This involves the Fed reducing its holdings of assets, mainly government bonds and government-backed mortgage-related securities.

This, however, for the time being will not include selling its holding of bonds or mortgage-backed securities. Rather, it will simply mean not buying new assets to replace ones when they mature, or only replacing part of the them. This was discussed by the 75 participants at the joint meeting of the Federal Open Market Committee (FOMC) and Board of Governors on 14–15 March.

As the minutes put it: “Many participants emphasized that reducing the size of the balance sheet should be conducted in a passive and predictable manner.”

A more active form of QT would involve selling assets before maturity and thus reducing the size of the Fed’s balance sheet more rapidly. But either way, reducing assets would put downward pressure on the money supply and support the higher interest rates planned by the FOMC.

The question is whether there is enough liquidity elsewhere in the system and enough demand for credit, and willingness of the banking system to supply credit, to allow a sufficient growth in broad money – sufficient, that is, to support continued growth in the economy. The answer to that question depends on confidence. The Fed, not surprisingly, is keen not to damage confidence and hence prefers a gradualist approach to reducing its holdings of assets bought during the various rounds of quantitative easing.

Fed’s asset shift to pose new test of economy’s recovery, resilience Reuters, Howard Schneider and Richard Leong (6/4/17)
Federal Reserve likely to begin cutting back $4.5 trillion balance sheet this year Washington Post, Ana Swanson (5/4/17)
Why the Fed’s debate about shrinking its balance sheet really, really matters Money Observer, Russ Mould (7/4/17)
The Fed and ECB keep a cautious eye on the exit Financial Times (7/4/17)
Get ready for the Fed’s next scary policy change CBS Money Watch, Anthony Mirhaydari (5/4/17)
The Fed wants to start shrinking its $4.5 trillion balance sheet later this year Business Insider, Akin Oyedele (5/4/17)
Inside the Fed’s March Meeting: The Annotated Minutes Bloomberg, Luke Kawa, Matthew Boesler and Alex Harris (5/4/17)
QE was great for asset prices – will ‘QT’ smash them? The Financial Review (Australia), Patrick Commins (7/4/17)
Shrinking the Fed’s balance sheet Brookings, Ben Bernanke (26/1/17)

Selected data Board of Governors of the Federal Reserve System


  1. Distinguish between active and passive QT.
  2. If QE is a form of expansionary monetary policy, is QT a form of contractionary monetary policy?
  3. Could QT take place alongside an expansion of broad money?
  4. What dangers lie in the Fed scaling back its holdings of government (Treasury) bonds and mortgage-backed securities?
  5. Why is it unlikely that the Fed will reduce its holdings of securities to pre-crisis levels?
  6. Why are the Bank of England, the ECB and the Bank of Japan still pursuing a policy of QE?
  7. What are the implications for exchange rates of QT in the USA and QE elsewhere?
  8. Find out data for the monetary base, for narrow money (M1) and broader money (M2) in the USA. Are narrow and/or broad money correlated with Federal Reserve asset holdings?
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A seven-year emergency

Seven years ago (on 5 March 2009), the Bank of England reduced interest rates to a record low of 0.5%. This was in response to a deepening recession. It mirrored action taken by other central banks across the world as they all sought to stimulate their economies, which were reeling from the financial crisis.

Record low interest rates, combined with expansionary fiscal policy, were hoped to be enough to restore rates of growth to levels experienced before the crisis. But they weren’t. One by one countries increased narrow money through bouts of quantitative easing.

But as worries grew about higher government deficits, brought about by the expansionary fiscal policies and by falling tax receipts as incomes and spending fell, so fiscal policy became progressively tighter. Thus more and more emphasis was put on monetary policy as the means of stimulating aggregate demand and boosting economic growth.

Ultra low interest rates and QE were no longer a short-term measure. They persisted as growth rates remained sluggish. The problem was that the higher narrow money supply was not leading to the hoped-for credit creation and growth in consumption and investment. The extra money was being used for buying assets, such as shares and houses, not being spent on goods, services, plant and equipment. The money multiplier fell dramatically in many countries (see chart 1 for the case of the UK: click here for a PowerPoint) and there was virtually no growth in credit creation. Broad money in the UK (M4) has actually fallen since 2008 (see chart 2: click here for a PowerPoint), as it has in various other countries.

Additional monetary measures were put in place, including various schemes to provide money to banks for direct lending to companies or individuals. Central banks increasingly resorted to zero or negative interest rates paid to banks for deposits: see the blog posts Down down deeper and down, or a new Status Quo? and When a piggy bank pays a better rate. But still bank lending has stubbornly failed to take off.

Some indication that the ‘emergency’ was coming to an end occurred in December 2015 when the US Federal Reserve raised interest rates by 0.25 percentage points. However, many commentators felt that that was too soon, especially in the light of slowing Chinese economic growth. Indeed, the Chinese authorities themselves have been engaging in a large scale QE programme and other measures to arrest this fall in growth.

Although it cut interest rates in 2009 (to 1% by May 2009), the ECB was more cautious than other central banks in the first few years after 2008 and even raised interest rates in 2011 (to 1.5% by July of that year). However, more recently it has been more aggressive in its monetary policy. It has progressively cut interest rates (see chart 3: click here for a PowerPoint) and announced in January 2015 that it was introducing a programme of QE, involving €60 billion of asset purchases for at least 18 months from March 2015. In December 2015, it announced that it would extend this programme for another six months.

The latest move by the ECB was on March 10, when it took three further sets of measures to boost the flagging eurozone economy. It cut interest rates, including cutting the deposit rate paid to banks from –0.3% to –0.4% and the main refinancing rate from –0.05% to –0%; it increased its monthly quantitative easing from €60 billion to €80 billion; and it announced unlimited four-year loans to banks at near-zero interest rates.

It would seem that the emergency continues!

QE, inflation and the BoE’s unreliable boyfriend: seven years of record low rates The Guardian, Katie Allen (5/3/16)
The End of Alchemy: Money, Banking and the Future of the Global Economy by Mervyn King – review The Observer, John Kampfner (14/3/16)
How ‘negative interest rates’ marked the end of central bank dominance The Telegraph, Peter Spence (21/2/16)
ECB stimulus surprise sends stock markets sliding BBC News (10/3/16)
5 Takeaways From the ECB Meeting The Wall Street Journal, Paul Hannon (10/3/16)
ECB cuts interest rates to zero amid fears of fresh economic crash The Guardian, Katie Allen and Jill Treanor (10/3/16)
Economists mixed on ECB stimulus CNBC, Elizabeth Schulze (10/3/16)
ECB’s Draghi plays his last card to stave off deflation The Telegraph, Ambrose Evans-Pritchard (10/3/16)
ECB cuts rates to new low and expands QE Financial Times, Claire Jones (10/3/16)
Is QE a saviour, necessary evil or the road to perdition? The Telegraph, Roger Bootle (20/3/16)

ECB materials
Monetary policy decisions ECB Press Release (10/3/16)
Introductory statement to the press conference (with Q&A) ECB Press Conference, Mario Draghi and Vítor Constâncio (10/3/16)
ECB Press Conference webcast ECB, Mario Draghi


  1. What are meant by narrow and broad money?
  2. What is the relationship between narrow and broad money? What determines the amount that broad money will increase when narrow money increases?
  3. Explain what is meant by (a) the credit multiplier and (b) the money multiplier.
  4. Explain how the process of quantitative easing is supposed to result in an increase in aggregate demand. How reliable is this mechanism?
  5. Find out and explain what happened to the euro/dollar exchange rate when Mario Draghi made the announcement of the ECB’s monetary measures on 10 March.
  6. Is there a conflict for central banks between trying to strengthen banks’ liquidity and reserves and trying to stimulate bank lending? Explain.
  7. Why are “the ECB’s policies likely to destroy half of Germany’s 1500 savings and co-operative banks over the next five years”? (See the Telegraph article.
  8. What are the disadvantages of quantitative easing?
  9. What are the arguments for and against backing up monetary policy with expansionary fiscal policy? Consider different forms that this fiscal policy might take.
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ECB signals further monetary easing

Mario Draghi, the ECB President, has indicated that the ECB is prepared to engage in further monetary stimulus. This is because of continuing weaknesses in the global economy and in particular in emerging markets.

Although the ECB at its meeting in Malta on 22 October decided to keep both interest rates and asset purchases (€60 billion per month) at current levels, Mario Draghi stated at the press conference that, at its next meeting on December 3rd, the ECB would be prepared to cut interest rates and re-examine the size, composition and duration of its quantitative easing programme. He stopped short, however, of saying that interest rates would definitely be cut or quantitative easing definitely increased. He said the following:

“The Governing Council has been closely monitoring incoming information since our meeting in early September. While euro area domestic demand remains resilient, concerns over growth prospects in emerging markets and possible repercussions for the economy from developments in financial and commodity markets continue to signal downside risks to the outlook for growth and inflation. Most notably, the strength and persistence of the factors that are currently slowing the return of inflation to levels below, but close to, 2% in the medium term require thorough analysis.

In this context, the degree of monetary policy accommodation will need to be re-examined at our December monetary policy meeting, when the new Eurosystem staff macroeconomic projections will be available. The Governing Council is willing and able to act by using all the instruments available within its mandate if warranted in order to maintain an appropriate degree of monetary accommodation.”

Mario Draghi also argued that monetary policy should be supported by fiscal policy and structural policies (mirroring Japan’s three arrows). Structural policies should include actions to improve the business environment, including the provision of an adequate public infrastructure. This is vital to “increase productive investment, boost job creation and raise productivity”.

As far as fiscal policies are concerned, these “should support the economic recovery, while remaining in compliance with the EU’s fiscal rules”. In other words, fiscal policy should be expansionary, while staying within the limits set by the Stability and Growth Pact.

His words had immediate effects in markets. Eurozone government bond yields dropped to record lows and the euro depreciated 3% against the US dollar over the following 24 hours.

ECB Press Conference on YouTube, Mario Draghi (22/10/15)
Draghi reloads bazooka FT Markets, Ferdinando Guigliano (22/10/15)

Mario Draghi: ECB prepared to cut interest rates and expand QE The Guardian, Heather Stewart (22/10/15)
Draghi signals ECB ready to extend QE Financial Times, Claire Jones and Elaine Moore (22/10/15)
Dovish Mario Draghi sends bond yields to new lows Financial Times, Katie Martin (23/10/15)
What Draghi Said on QE, Policy Outlook, Global Risks and Inflation Bloomberg, Deborah Hyde (22/10/15)
ECB set to ‘re-examine’ stimulus policy at next meeting BBC News (22/10/15)
The global economy warrants a big dose of caution The Guardian, Larry Elliott (25/10/15)

ECB Press Conference
Introductory statement to the press conference (with Q&A) ECB, Mario Draghi (President of the ECB), Vítor Constâncio (Vice-President of the ECB) (22/10/15)


  1. Why is the ECB considering further expansionary monetary policy?
  2. What monetary measures can a central bank use to stimulate aggregate demand?
  3. Explain the effects of Mario Draghi’s announcement on bond and foreign exchange markets.
  4. What are the objectives of ECB monetary policy according to the its mandate?
  5. Should the ECB consider using quantitative easing to provide direct funding for infrastructure projects?
  6. What constraints does the EU’s Stability and Growth Pact impose on eurozone countries?
  7. What are the arguments for and against (a) the Bank of England and (b) the US Federal Reserve engaging in further QE?
  8. If the ECB does engage in an expanded QE programme, what will determine its effectiveness?
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People’s quantitative easing

Jeremy Corbyn, the newly elected leader of the Labour Party, is proposing a number of radical economic policies. One that has attracted considerable attention is for a new form of QE, which has been dubbed ‘people’s quantitative easing’.

This would involve newly created money by the Bank of England being directly used to fund spending on large-scale housing, energy, transport and digital projects. Rather than the new money being used to purchase assets, as has been the case up to now, with the effect filtering only indirectly into aggregate demand and even more indirectly into aggregate supply, under the proposed scheme, both aggregate demand and aggregate supply would be directly boosted.

Although ‘conventional’ QE has worked to some extent, the effects have been uneven. Asset holders and those with large debts, such as mortgages, have made large gains from higher asset prices and lower interest rates. By contrast, savers in bank and building society accounts have seen the income from their savings decline dramatically. What is more, the indirect nature of the effects has meant time lags and uncertainty over the magnitude of the effects.

But despite the obvious attractiveness of the proposals, they have attracted considerable criticism. Some of these are from a political perspective, with commentators from the right arguing against an expansion of the state. Other criticisms focus on the operation and magnitude of the proposals

One is that it would change the relationship between the Bank of England and the government. If the Bank of England created money to fund government projects, that would reduce or even eliminate the independence of the Bank. Independence has generally been seen as desirable to prevent manipulation of the central bank by the government for short-term political gain. Those in favour of people’s QE argue that the money would be directed into a National Investment Bank, which would then make the investment allocation decisions. The central bank would still be independent in deciding the amount of QE.

This leads to the second criticism and that is about whether further QE is necessary at the current time. Critics argue that while QE of whatever type was justified when the economy was in recession and struggling to recover, now would be the wrong time for further stimulus. Indeed, it could be highly inflationary. The economy is currently expanding. If banks respond by increasing credit, the velocity of circulation of narrow money could rise and broad money supply grow, providing enough money to underpin a growing economy.

Many advocates of people’s QE accept this second point and see it as a contingency plan in case the economy fails to recover and further monetary stimulus is deemed necessary. If further QE is not felt necessary by the Bank of England, then the National Investment Bank could fund investment through conventional borrowing.

The following articles examine people’s QE and look at its merits and dangers. Given the proposal’s political context, several of the articles approach the issue from a very specific political perspective. Try to separate the economic analysis in the articles from their political bias.

Jeremy Corbyn’s proposal
The Economy in 2020 Jeremy Corbyn (22/7/15)

People’s quantitative easing — no magic Financial Times, Chris Giles (13/8/15)
How Green Infrastructure Quantitative Easing would work Tax Research UK, Richard Murphy (12/3/15)
What is QE for the people? Money Week, Simon Wilson (22/8/15)
QE or not QE? A slippery slope to breaking the Bank, David Smith (23/8/15)
We don’t need “People’s QE”, basic economic literacy is enough Red Box, Jonathan Portes (13/8/15)
Is Jeremy Corbyn’s policy of ‘quantitative easing for people’ feasible? The Guardian, Larry Elliott (14/8/15)
Corbynomics: Quantitative Easing for People (PQE) Huffington Post, Adnan Al-Daini (7/9/15)
Corbyn’s “People’s QE” could actually be a decent idea FT Alphaville, Matthew C. Klein (6/8/15)
Jeremy Corbyn’s ‘People’s QE’ would force Britain into three-year battle with the EU The Telegraph, Peter Spence (15/8/15)
Would Corbyn’s ‘QE for people’ float or sink Britain? BBC News, Robert Peston (12/8/15)
Strategic Quantitative Easing – public money for public benefit New Economics Foundation blog, Josh Ryan-Collins (12/8/15)
People’s QE and Corbyn’s QE Mainly Macro blog, Simon Wren-Lewis
You can print money, so long as it’s not for the people The Guardian, Zoe Williams (4/10/15)


  1. What is meant by ‘helicopter money’? How does it differ from quantitative easing as practised up to now?
  2. Is people’s QE the same as helicopter money?
  3. Can people’s QE take place alongside an independent Bank of England?
  4. What is meant by the velocity of circulation of money? What happened to the velocity of circulation following the financial crisis?
  5. How does conventional QE feed through into aggregate demand?
  6. Under what circumstances would people’s QE be inflationary?
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All eased out: at least for the USA and UK

Following the recession of 2008/9, the UK has engaged in four rounds of quantitative easing (QE) – the process whereby the central bank increases the money supply by purchasing government bonds, and possibly other assets, on the open market from various institutions. The final round was announced in July 2012, bringing the total assets purchased to £375bn. As yet, however, there are no plans for quantitative tightening – the process of the Bank of England selling some of these assets, thereby reducing money supply.

The aim of QE has been to stimulate aggregate demand. Critics claim, however, that the effect on spending has been limited, since the money has not gone directly to consumers but rather to the institutions selling the assets, who have used much of the money to buy shares, bonds and other assets. Nevertheless, with banks having to strengthen their capital base following the financial crisis, QE has helped then to achieve this without having to make even bigger reductions in lending.

The Bank of England now reckons that the recovery is sufficiently established and there is, therefore, no need for further QE.

This is also the judgement of the Federal Reserve about the US economy, which experienced annual growth of 3.5% in the third quarter of 2014. The IMF predicts that US growth will be around 3% for the next three years.

The Fed has had three rounds of QE since the financial crisis, but in October 2014 called an end to the process. Since the start of this year, it has been gradually reducing the amount it injects each month from $85bn to $15bn. The total bond purchases over the past five years have been some $3.6tn, bringing the Fed’s balance sheet to nearly $4.5tn.

But as QE comes to an end in the USA, Japan is expanding its programme. On 31 October, the Bank of Japan announced that it would increase its asset purchases from ¥60-70tn per year to ¥80tn (£440bn). The Japanese government and central bank are determined to boost economic growth in Japan and escape the two decades of deflation and stagnation. The Tokyo stock market rose by some 8% in the week following the announcement and the yen fell by more than 5% against the dollar.

And the European Central Bank, which has not used full QE up to now, looks as if it is moving in that direction. In October, it began a programme of buying asset-backed securities (ABSs) and covered bonds (CBs). These are both private-sector securities: ABSs are claims against non-financial companies in the eurozone and CBs are issued by eurozone banks and other financial institutions.

It now looks as if the ECB might take the final step of purchasing government bonds. This is probably what is implied by ECB President Mario Draghi’s statement after the 6 November meeting of the ECB that the ground was being prepared for “further measures to be implemented, if needed”.

But has QE been as successful as its proponents would claim? Is it the solution now to a languishing eurozone economy? The following articles look at these questions.

Fed calls time on QE in the US – charts and analysis The Guardian, Angela Monaghan (29/10/14)
Quantitative easing: giving cash to the public would have been more effective The Guardian, Larry Elliott (29/10/14)
End of QE is whimper not bang BBC News, Robert Peston (29/10/14)
Federal Reserve ends QE The Telegraph, Katherine Rushton (29/10/14)
Bank of Japan to inject 80 trillion yen into its economy The Guardian, Angela Monaghan and Graeme Wearden (31/10/14)
Every man for himself The Economist, Buttonwood column (8/11/14)
Why Japan Surprised the World with its Quantitative Easing Announcement Townhall, Nicholas Vardy (7/11/14)
Bank of Japan QE “Treat” Is a Massive Global Trick Money Morning, Shah Gilani (31/10/14)
ECB stimulus may lack desired scale, QE an option – sources Reuters, Paul Carrel and John O’Donnell (27/10/14)
ECB door remains open to quantitative easing despite doubts over impact Reuters, Eva Taylor and Paul Taylor (9/11/14)
ECB could pump €1tn into eurozone in fresh round of quantitative easing The Guardian,
Angela Monaghan and Phillip Inman (6/11/14)
Ben Bernanke: Quantitative easing will be difficult for the ECB CNBC, Jeff Cox (5/11/14)
Not All QE Is Created Equal as U.S. Outpunches ECB-BOJ Bloomberg, Simon Kennedy (6/11/14)
A QE proposal for Europe’s crisis The Economist, Yanis Varoufakis (7/11/14)
UK, Japan and 1% inflation BBC News, Linda Yueh (12/11/14)
Greenspan Sees Turmoil Ahead As QE Market Boost Unwinds Bloomberg TV, Gillian Tett interviews Alan Greenspan (29/10/14)


  1. What is the transmission mechanism between central bank purchases of assets and aggregate demand?
  2. Under what circumstances might the effect of a given amount of QE on aggregate demand be relatively small?
  3. What dangers are associated with QE?
  4. What determines the likely effect on inflation of QE?
  5. What has been the effect of QE in developed countries on the economies of developing countries? Has this been desirable for the global economy?
  6. Have businesses benefited from QE? If so, how? If not, why not?
  7. What has been the effect of QE on the housing market (a) in the USA; (b) in the UK?
  8. Why has QE not been ‘proper’ money creation?
  9. What effect has QE had on credit creation? How and why has it differed between the USA and UK?
  10. Why did the announcement of further QE by the Bank of Japan lead to a depreciation of the yen? What effect is this depreciation likely to have?
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The ECB: tackling the threat of deflation

The spectre of deflation haunts the eurozone economy. Inflation in the 12 months to May 2014 was 0.5%, down from 0.7% to April and well below the target of 2% (see). Price deflation can result in deflation of the whole economy. With the prospect of falling prices, many consumers put off spending, hoping to buy things later at a lower price. This delay in spending deflates aggregate demand and can result in a decline in growth or even negative growth: hardly a welcome prospect as the eurozone still struggles to recover from the long period of recession or sluggish growth that followed the 2007–8 financial crisis.

The ECB is well aware of the problem. Its President, Mario Draghi, has stated on several occasions that the central bank will do whatever it takes to ward off deflation and stimulate recovery. At its monthly meeting on 5 June, the ECB Council acted. It took the following measures (see Mario Draghi’s press conference and the press release):

• The main refinancing rate it charges banks on reverse repos (when using open-market operations) was cut from 0.25% to 0.15%.
• The rate it pays banks for depositing money in the ECB was cut from 0% to –0.1%. In other words, banks would be charged for ‘parking’ money with the ECB rather than lending it.
• It will provide targeted lending to banks (targeted longer-term refinancing operations (TLTROs)), initially of 7% of the total amount of each banks’ loans to the non-financial private sector within the eurozone. This will be provided in two equal amounts, in September and December 2014. These extra loans will be for bank lending to businesses and households (other than for house purchase). The total amount will be some €400 billion. Substantial additional lending will be made available quarterly from March 2016 to June 2016.
• It will make preparations for an asset purchase scheme. Unlike that in the UK, which involves the purchase of government bonds, this will involve the purchase of assets which involve claims on private-sector (non-financial) institutions. Depending on financing arrangements, this could amount to quantitative easing.
• It will suspend sterilising the extra liquidity that has been injected under the Securities Markets Programme (operated from May 2010 to September 2012), which involved purchasing eurozone countries’ existing bonds on the secondary market. In other words it will stop preventing the securities that have been purchased from increasing money supply. This therefore, for the first time, represents a genuine form of quantitative easing.

The question is whether the measures will be enough to stimulate the eurozone economy, prevent deflation and bring inflation back to around 2%. The measures are potentially significant, especially the prospect of quantitative easing – a policy pursued by other main central banks, such as the Fed, the Bank of England and the Bank of Japan. A lot depends on what the ECB does over the coming months.

The following articles consider the ECB’s policy. The first ones were published before the announcement and look at alternatives open to the ECB. The others look at the actual decisions and assess how successful they are likely to be.

Articles published before the announcement
Mario Draghi faces moment of truth as man with power to steady eurozone The Observer, Larry Elliott (1/6/14)
What the ECB will do in June? Draghi spells it out The Economist (26/5/14)
Draghi as Committed as a Central Banker Gets, as Economists Await ECB Stimulus Bloomberg, Alessandro Speciale and Andre Tartar (19/5/14)
ECB’s credit and credibility test BBC News, Robert Peston (2/6/14)
90 ECB decamps to debate monetary fixes Financial Times, Claire Jones (25/5/14)

Monetary policy in a prolonged period of low inflation ECB, Mario Draghi (26/5/14)

Articles published after the announcement
ECB launches €400bn scheme, seeks to force bank lending Irish Independent (5/6/14)
The ECB’s toolbox BBC News, Linda Yueh (5/6/14)
ECB’s justified action will help but is no panacea for eurozone deflationary ills The Guardian, Larry Elliott (5/6/14)
Why Negative Rates Won’t Work In The Eurozone Forbes, Frances Coppola (4/6/14)
Germany’s fear of QE is what’s stopping us from cracking open the Cava The Telegraph, Roger Bootle (8/6/14)

Euro area economic and financial data ECB


  1. Why has the eurozone experienced falling inflation and a growing prospect of negative inflation?
  2. Explain how the Securities Markets Programme (SMP) worked (check it out on the ECB site). What countries’ bonds were purchased and why?
  3. What is meant by sterilisation? Why did the ECB sterilise the effects of the assets purchased under the SMP?
  4. If it is practical for the ECB to set a negative interest rate on the deposit facility for banks, would it be practical to set a negative interest rate for the main refinancing operations or the marginal lending facility? Explain.
  5. Why has the ECB, up to now, been unwilling to engage in quantitative easing? What has changed?
  6. Why may the introduction of a negative interest rate on bank deposits in the ECB have only a very small effect on bank lending?
  7. How much is broad money supply growing in the eurozone? Is this enough or too much? Explain.
  8. What else could the ECB have done to ward off deflation? Should the ECB have adopted these measures?
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Deflation danger in the eurozone

‘Deflation could be replacing debt as the main problem – and there’s nothing to suggest the ECB is up to the job.’ So begins the linked article below by Barry Eichengreen, Professor of Economics and Political Science at the University of California, Berkeley.

The good news in this is that worries about debt in eurozone countries are gradually receding. Indeed, this week Ireland officially ended its reliance on a bailout (of €67.5 billion) from the EU and IMF and regained financial sovereignty (see also).

The bad news is that this does not mark the end of austerity. Indeed, many eurozone countries could get stuck in a deflationary trap, with austerity policies continuing to depress aggregate demand. Eurozone inflation is less than 1% and falling. Broad money supply growth is now below that of the US dollar, the yen and sterling (see chart: click here for a PowerPoint).

The ECB has been far more cautious than central banks in other countries in acting to prevent recession and deflation. Unlike the USA, Japan and the UK, which have all engaged in extensive quantitative easing, the ECB had been reluctant to do so for fear of upsetting German opinion and taking the pressure off southern European countries to reform.

But as Eichengreen points out, the dangers of inaction could be much greater. What is more, quantitative easing is not the only option. The ECB could copy the UK approach of ‘funding for lending’ – not for housing, but for business.

Europe’s economic crisis could be mutating again The Guardian, Barry Eichengreen (10/12/13)


  1. What problems are created by falling prices?
  2. What effect would deflation have on debt and the difficulties in repaying that debt?
  3. What measures have already been adopted by the ECB to stimulate the eurozone economy? (Search previous articles on this site.)
  4. Why have such measures proved inadequate?
  5. What alternative policies are open to the ECB?
  6. What are the arguments for the ECB being given a higher inflation target (such as 3 or 4%)?
  7. What are the arguments for and against relaxing fiscal austerity in the eurozone at the current time?
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Tapering off? Not yet

As we saw in the news item The difficult exit from cheap money, central banks around the world have been operating an extremely loose monetary policy since the beginning of 2009. Their interest rates have been close to zero and trillions of dollars of extra money has been injected into the world economy through various programmes of quantitative easing.

For the past few months the Federal Reserve has been purchasing bonds under its most recent programme dubbed QE3, and thereby increasing narrow money, by $85 billion per month. Since the start of its QE programme in 2009, it has pumped around $2.8 trillion of extra money into the US and world economies. This huge increase in money supply has boosted the demand for assets worldwide and world stock markets have risen. Much of the money has flowed into developing countries, such as India, and has acted as a boost to their economies.

Once the US economy is growing strongly again, the aim is to taper off, and ultimately end or even reverse, the QE programme. It was expected that the Fed would decide to start this tapering off process at its meeting on 18 September – perhaps reducing bond purchases initially by some $10 billion. (Note that this would still be an increase in money supply, just a slightly smaller one.) Over the past few days, US bond prices have been falling (and yields increasing) in anticipation of such a move.

As it turned out, the Fed decided to delay tapering off. It will continue with its assets purchase programme of $85 billion per month for the time being. The reason given was that the US economy was still too fragile and needed the monthly injections of money to stay at the current level.

Normally it might be expected that the announcement of a more fragile recovery would cause the US stock market, and others worldwide, to fall. In fact the opposite occurred, with investors relieved that the extra money, which allows extra asset purchases, would continue at the same rate.

But this then raises the question of just what will be the effect when tapering off does actually occur. Will stock markets then go into a tailspin? Or will they merely stop rising so fast. That depends very much on the role of speculation.

Bernanke’s Own Words on Asset Purchases, Economy Bloomberg (18/9/13)
Bernanke: Fed to delay bond tapering PBS Newshour on YouTube (full speech plus questions) (18/9/13)
No tapering announced by Fed CNBC on Yahoo Finance (18/9/113)
The impact of US stimulus moves at home and abroad BBC News, Stephanie Flanders (18/9/13)
Is the upturn reaching Americans? BBC World, Stephanie Flanders (17/9/13)
Shares hit high as Federal Reserve maintains stimulus BBC News, Stephanie Flanders (18/9/13)
US Fed decision to delay tapering was a relief ET Now (India), Bimal Jalan (19/9/13)

Federal Reserve surprises markets by delaying QE tapering The Telegraph, Katherine Rushton (18/9/13)
Federal Reserve delays QE tapering: the full statement The Telegraph (18/9/13)
Q&A: What is tapering? BBC News (18/9/13)
Fed delay is no reason to celebrate The Guardian, Larry Elliott (19/9/13)
Federal Reserve tapering decision has baffled the markets The Guardian, Larry Elliott (19/9/13)
Taper tiger The Economist (21/9/13)
Everything You Need to Know About the Fed’s Decision Not to Taper QE3 The Atlantic, Matthew O’Brien (18/9/13)
Fed’s dovish turn leaves Wall Street economists mulling taper timing: poll Reuters, Chris Reese (18/9/13)
Good news and bad news from the Fed BBC News, Stephanie Flanders (19/9/13)
Is the Fed frightened of its shadow? BBC News, Robert Peston (19/9/13)
The Federal Reserve and Janet Yellen face a tough task with insufficient tools The Guardian, Mohamed A. El-Erian (14/10/13)


  1. Why might a slowing down in the increase in US money supply cause asset prices to fall, rather than merely to rise less quickly?
  2. Why has the US QE programme led to a rise in asset prices overseas?
  3. Distinguish between stabilising and destabilising speculation. Which type of speculation has been occurring as a result of the US QE programme?
  4. How has QE affected unemployment in the UK and USA? How is the participation rate and the flexibility of labour markets relevant to the answer?
  5. Explain the following two statements by Stephanie Flanders and Robert Peston respectively. “The market conditions argument has a circularity to it: talk of tapering leads to higher market rates, which in turn puts the taper itself on hold.” “The Fed simply hinting that less money would be created, means that there will be no reduction in the amount of money created (for now at least).”
  6. Why have US long-term interest rates, including mortgage rates, risen since May of this year?
  7. What impact have higher US long-term interest rates had on economies in the developing world? Explain.
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Launch of America’s QE3

The US Federal Reserve bank has launched a third round of quantitative easing, dubbed QE3. The hope is that the resulting growth in money supply will stimulate spending and thereby increase growth and employment.

Ben Bernanke, the Fed Chairman, had already said that the stagnation of the labour market is of grave concern because of “the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years”. Not, surprisingly, the markets were expecting strong action – and that is what they got.

Under QE3, the Fed will buy mortgage-backed securities of $40bn per month. And this will go on for as long as it takes for the employment market to show significant improvement. It is this open-ended commitment which makes QE3 different from QE1 and QE2. Under these earlier rounds of quantitative easing, the Fed purchased a fixed amount of assets – $2.3tn of bonds.

QE3 also comes on top of a policy in operation since September 2011 of buying long-term government bonds in the market and selling shorter-dated ones. This ‘funding’ operation is known as ‘Operation Twist’.

The markets responded favourably to the announcement of QE3, especially to the fact that its size and duration would depend on the state of the real economy. Nevertheless, there are real questions about its likely effectiveness. The most important is whether the increase in narrow money will translate into an increase in borrowing and spending and hence an increase in broad money; or whether the rise in narrow money will be offset by a fall in the velocity of circulation as banks seek to increase their liquidity ratios and to recapitalise.

The following articles look at the details of QE3 and whether it is likely to achieve its desired result. Will the Fed be forced to raise asset purchases above $40bn per month or to introduce other measures?

Federal Reserve to buy more debt to boost US economy BBC News (14/9/12)
Bernanke takes plunge with QE3 Financial Times, Robin Harding (14/9/12)
US monetary policy at an important turning point Financial Times, Gavyn Davies (2/9/12)
Cliffhanger The Economist (22/9/12)
Your flexible Fed BBC News, Stephanie Flanders (13/9/12)
Back Ben Bernanke’s QE3 with a clothes peg on your nose The Telegraph, Ambrose Evans-Pritchard (23/9/12)
QE3 Stimulus from Federal Reserve Drives Mortgage Rates Down to Record Lows TellMeNews, Sharon Wagner (24/9/12)
Helicopter Ben Bernanke: The Problem With QE1, QE2, QE3 and QE Infinity TellMeNews, Martin Hutchinson (18/9/12)
QE: More bang than buck Business Spectator, Stephen Grenville (18/9/12)
QE3: What it Really Means PBS NewsHour, Paul Solman (20/9/12)

US Data
US Money Stock Measures Federal Reserve Statistical Release
Data Releases Board of Governors of the Federal Reserve System
Civilian Unemployment Rate (UNRATE) FRED Economic Data


  1. What distinguishes the Fed’s QE3 from its QE1 and 2?
  2. What will determine the likely success of QE3 in stimulating the real economy?
  3. Why has there been a huge surge in liquidity preference in the USA? What would have been the impact of this without QE1 and QE2?
  4. Explain what is meant by ‘portfolio balance effects’ and how significant are these in determining the success of quantitative easing?
  5. Does QE3 suggest that the Fed is pursuing a type of Taylor Rule?
  6. Why might QE3 be a “pro-cyclical” blunder?
  7. To what extent would monetarists approve of the Fed’s policies on QE?
  8. How is QE3 likely to affect the dollar exchange rate and what implications will this have for countries trading with the USA?
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An economic puzzle

Between December 2007 and March 2009, the Bank of England reduced Bank Rate on several occasions in order to stimulate the economy and combat recession. By March 2009, the rate stood at a record low of 0.5%. Each month the Monetary Policy Committee meets to decide on interest rates and since March 2009, the members’ decision has consistently been that Bank Rate needs to remain at 0.5%.

Although the UK economy has been making tentative steps towards recovery, it is still in a very vulnerable state. Last month, the Bank of England extended its programme of quantitative easing to a total £325bn stimulus. This, together with the decision to keep interest rates down and with the shock fall in manufacturing output contributing towards first quarter growth of just 0.1%, is a key indication that the UK economy is still struggling, even though the central bank thinks it unlikely that the UK will re-enter recession this year.

Monetary policy in the UK has been very much geared towards stimulating economic growth, despite interest rates typically being the main tool to keep inflation on target at 2%. The problem facing the central bank is that economic growth and inflation are in something of a conflict. Low interest rates to stimulate economic growth also create a higher inflation environment and that is the trade-off the economy has faced. Inflation has been well above its target for some months (a high of 5.2% in September 2011), and the low interest rate environment has done little to deflate the figure. After all, low interest rates are a monetary instrument that can be used to boost aggregate demand, which can then create demand-pull inflation. However, inflation is now slowly beginning to fall, but this downward trend could be reversed with the sky high oil prices we are recently experiencing. If inflation does begin to creep back up, the Monetary Policy Committee will once again face a decision: keep Bank Rate low and continue with quantitative easing to stimulate the economy or increase Bank Rate to counter the higher rate of inflation.

The data over recent months has been truly inconsistent. Some indicators suggest improvements in the economy and the financial environment, whereas others indicate an economic situation that is moving very quickly in the wrong direction. A key factor is that the direction the UK economy takes is very much dependent on the world economy and, in particular, on how events in the eurozone unfold. The following articles consider some of the latest economic developments.

UK economy grew 0.1% to avoid recession, says NIESR Guardian, Katie Allen (5/4/12)
UK interest rates held at 0.5% BBC News (5/4/12)
UK just about avoided recession in Q1, NIESR says Telegraph, Angela Monaghan (5/4/12)
Bank of England keeps interest rates on hold at 0.5pc Telegraph (5/4/12)
UK economy ‘weak but showing signs of improvement’ BBC News (3/4/12)
Bank of England holds on quantitative easing and interest rates Guardian, Katie Allen (5/4/12)
Faith on Tories on economy hits new low Financial Times, Helen Warrell (6/4/12)


  1. Which factors will the Monetary Policy Committee consider when setting interest rates?
  2. Using a diagram to help your answer, illustrate and explain the trade-off that the MPC faces when choosing to keep interest rates low or raise them.
  3. What is quantitative easing? How is it expected to boost economic growth in the UK?
  4. Which factors are likely to have contributed towards the low growth rate the UK economy experienced in the first quarter of 2012?
  5. Explain the trends that we have seen in UK inflation over the past year. What factors have caused the figure to increase to a high in September and then fall back down?
  6. What do you expect to happen to inflation over the next few months? To what extent is your answer dependent on the MPC’s interest rate decisions?
  7. Although the official figures suggest that the UK avoided a double-dip recession, do you agree with this assessment? Explain your answer.
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