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Business Economics and Organization William Mosca

Quantitative Easing
Introduction

In the following brief paper is analyzed the concept of Quantitative Easing, its economic background, and the reasons whereby it is
performed currently and in the past.

Moreover it has been briefly analysed the case of the UK, which in 2009 started a QE operation in order to address the crisis
crackdown of the previous years.

Finally it is presented my personal judgment on the analyzed QE operation.

Theoretical elements

The background

As to the background it is worth to briefly summarize the so called conventional monetary policies, that can be performed by a
central bank if need be.

As first we can define a monetary policy as the actions of a central bank to determine the size and rate of growth of the money
supply and so the interest rates.

The target is achieved by buying and selling government bonds or potentially by regulating the size of the bank reserves or by
setting the interbanking interest rate.

In Europe this role is played by the so called ECB, whereas in the US by the Federal reserve.

Generally speaking, there are two kinds of monetary policy, known as expansionary and contractionary. An expansionary monetary
policy is identified by an increase in the money supply, and its main goal is to stimulate the economic growth by boosting the
private sector borrowing (thanks to the lower interest rates) and the consumer spending.

Such a policy is typically employed in case of financial crisis, to contrast its effects, such us the growth of the unemployment and
the drop in investments and consumption.
The opposite action is known as contractionary monetary policy and it is identified by a reduction in the money supply, mainly with
the aim of controlling the inflation rate.

Such kind of policy may be detrimental for the economy due to the raise of the interest rates, and it may slow the economic growth
along with all the negative effects that might arise on the society, like as unemployment, cut in consumer spending and borrowing.

In the most severe cases it may even eventuate in a recession, but sometimes it is a necessary action to turn down the inflation
growth.

Contractionary and expansionary monetary policy are commonly called open market operation, and the following pictures depict
the strict relation of money supply and interest rate (at least in this model).

Fig.1a expansionary monetary policy Fig.1b contractionary monetary policy

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Business Economics and Organization William Mosca

Unconventional monetary policies

It is worth to highlight that with the term unconventional it is stressed the fact that such actions were supposed to be exceptional
and temporary but in some cases ended up to be standard and permanent.

The main so called unconventional monetary policies adopted in the wake of the financial crisis are the balance sheet policies
(commonly termed quantitative easing), the forward guidance and the negative policy rates.

It follows a brief investigation on these three policies, with particular emphasis on the quantitative easing.

The forward guidance

The forward guidance is an action that attempts to influence the financial decisions of households, businesses and investors by
letting them know what to expect from interest rates. Practically the central bank foretells to the public its future actions in order
to act on their expectations and to prevent surprises that might disrupt the markets and cause significant fluctuations in asset
prices.

Furthermore, the central bank clearly declares what conditions will make it to stay the course, and what will make it to change
policy.

It can be considered an important central banks tool and it has been largely employed by central banks such as the Federal
Reserve, the ECB, the Bank of England, and the Bank of Japan.

The negative policy rates

It consists in a tool used in unconventional monetary policies, whereby nominal target interest rates are set with a negative value,
below the theoretical lower bound of zero percent.

It is employed during deflating periods to contrast the tendency to put aside money of consumers, households and businesses. In
fact such phenomena causes the drop of the aggregate demand and so of the prices, that get furtherly reduced, bearing severe
effects on the economy, such as reduction in production and unemployment.

The deflection is often associated to a long economic crises or recession indeed.

The common employed tool to hedge against the deflection is an expansionary monetary policy, but sometimes to reduce to zero
the central bank interest rates may be ineffective due to strong deflationary forces.

A negative interest rate means that the central bank will charge negative interest: instead of receiving money on deposits,
depositors must pay regularly to keep their money with the bank. This is intended to incentivize banks to lend money more freely
and businesses and individuals to invest, lend, and spend money rather than pay a fee to keep it safe.

The Quantitative Easing

The Quantitative Easing is an unconventional monetary policy in which a central bank purchases government securities or other
securities from the market in order to lower interest rates and increase the money supply. Quantitative easing increases the money
supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. Quantitative easing is
considered when short-term interest rates are at or approaching zero, and does not involve the printing of new banknotes.

In fact, when the economy stalls and the central bank wants to encourage economic growth, it buys government bonds. This lowers
short-term interest rates and increases the money supply. This strategy loses effectiveness when interest rates approach zero, at
which point banks have to implement other strategies to boost the economy.

However the QE may have some negative effects on the economy, first of all, if it is carried out too quickly it may potentially boost
the inflation over the targeted value. In addition, the QE generally causes a depreciation in the value of the home country's
currency. This can be either positive or negative depending on the country.

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Business Economics and Organization William Mosca

Further, it is worth recalling that a central bank can give additional funds to banks, but can't force the banks to lend this money to
individuals and businesses. If this money does not end up in the hands of consumers, the lending to the banks will not impact the
money supply, and therefore will be ineffective at stimulating the economy.

Case of study: UK economy under the quantitative easing

In 2008, in order to contrast the further intensification of the financial crisis the UKs central bank, along with other central banks,
made use of both conventional and unconventional policy measures.

The UK on that regard performed a loosing monetary policy to boost the demand, known as Quantitative Easing, and cut interest
rates sharply, with cuts of 3% in Bank Rate during 2008 Q4 and a further 1,5% in early 2009. In early March 2009, Bank Rate was
reduced to 0,5%, effectively its lower bound. But, despite this substantial loosening in policy, the central bank judged that without
additional measures nominal spending would be too weak to meet the targeted inflation of 2% in the medium term.

The Bank of Englands asset purchases were mainly focused on purchasing a large amount of UK government bonds called gilts. In
fact between March 2009 and January 2010, the Bank purchased 200 billion of assets, mostly medium and long dated gilts.

Moreover, the government authorised the bank to pursue a number of activities targeted to improve the functioning of specific
financial markets such as purchases of high-quality commercial paper and corporate bonds.

The following picture give a comprehensive overview of the actions carried out by the UK central bank in relation to its goal.

The main purchasing action was made on the conventional gilts, hence it was expected to see a remarkable effect in that respect.
Effectively arose quite a big reaction in March 2009, when the QE was for the first time announced, but there was also a
remarkable reaction after the February 2009 Inflation Report and associated press conference, which suggested that a policy of
asset purchases was likely, and after the August announcement of a further extension of the programme (Fig.3).

Fig.3 Announcement impact on gilt yields, OIS rates and gilt-OIS spreads

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Business Economics and Organization William Mosca

For what concerns the Sterlin reaction, afterwards the QE six new announcements, it depreciated of about 4%, as it was largely
expected and subsequently recovered 1% of its value between March 2009 and May 2010.

The following picture shows the broad money trend along with the nominal GDP in a long range, highlighting its behaviour during
the crisis periods. From the onset of the financial crisis in 2007, broad money growth slowed dramatically in the United Kingdom,
falling from around 10% a year to below 1% a year in early 2010.

Since then, money growth has recovered slightly but remains still below nominal GDP growth (Fig.4).

Fig.4 Trend of GDP and Broad Money over time.

Let now analyse the UKs economy in a larger run, considering also the subsequent years till 2012, after the introduction on the QE
procedure in 2009.

As first it is worth to consider the GDP growth trend, as it is an effective tool to assess for the wealth of an economy, especially in
terms of output.

Fig.5 GDP growth over the run 2008/2012.

In Fig.5 we can observe the dramatic effects of the crisis crackdown in the 2008 autumn (Q4), that yielded to the decision of
implement the QE procedure. The GDP growth picked down to almost -2,4% in the fourth quarter indeed.

It is remarkable the trend reverse already in the early 2009 with the implementation of the QE that eventuated in a by far lower
percentage drop in GDP, around -0,2%, and finally came back to grow as of the third quarter.

Hence, in the period lasting from the end of 2009 and the end of 2010 arose a slow recovery of the economy that anyway did not
last steadily in the subsequent years. Indeed the UK entered again in a double dip recession in 2012.

Hence the QE did not yield to the hoped results, but it is worth to stress that without such action the recession may even have been
deeper.
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Business Economics and Organization William Mosca

The incomplete effectiveness of the QE may be ascribed to the fact that bank lending was very slow to recover, suggesting that it
was relatively ineffective in boosting bank lending.

However, UK bond yields fell during the period of quantitative easing. This made government borrowing cheaper, and in theory
encourages more profitable investment (Fig.6).

Fig.6 Trend of the Bond yield from 2007 to 2009.

Conclusions

The aim of this paper was to depict the unconventional monetary policy commonly known as Quantitative Easing, to explain its
context and how it has been applied in practice in the past.

It has been briefly analysed the case of the QE procedure started in 2009 by the UK central bank, observing data regarding as first
the prompt reaction of the markets to the QE procedure announcement and implementation and then describing the effective
trend that identified the UK economy in the following years up to 2012.

According to such data and my personal opinion the QE procedure had a positive impact on the UK economy, and from a
theoretical point of view it worked, acting with effectiveness on the Bond yields all over the run, and additionally had a positive
aftermath on the people and business expectation as it was announced.

However, it seemed straightforward that such a monetary policy is not enough to face a severe crises, and to prompt its
effectiveness it must be coupled to a reasonable fiscal policy. In addition it is worth to highlight that the economy trend is also
strongly affected by external parameters, such as the rest of the world growth, important especially when the state economy relies
strongly on the export (ex: UK, Italy). Hence, the subsequent slow economy recovery may be ascribed also to such external factors
rather than to the ineffectiveness of the QE procedure performed.

Hence, the QE was demonstrated to be an useful tool to hedge against a crisis and a recession, but still insufficient to annihilate its
side effects and neither able to effectively reverse the trend steadily in a medium run.

My final remark is that the QE procedure started in 2009 did not succeeded in arrest the crises, but to some extents mitigated its
severity.

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Business Economics and Organization William Mosca

Bibliography

1. www.investopedia.com.
2. MACROECONOMICS, Olivier Blanchard, David R. Johnson.
3. The financial crisis of 2007/2008 and its impact on the UK and other economies, University of Liverpool.
4. The United Kingdoms quantitative easing policy: design, operation and impact, Michael Joyce, Matthew Tong and
Robert Woods.
5. Quantitative Easing Definition, Problems and limitations of quantitative easing,Tejvan Pettinger.
6. Unconventional monetary policies: a re-appraisal, Claudio Borio, Anna Zabai.
7. http://www.ken-szulczyk.com/economics/economics_lesson_23.php.
8. http://www.mrmedico.info/apps/blog/categories/show/1885620-macro-unit-4-monetary-policy.