Impact of end of Fe's Quantitative Easing

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Will bank loans increase, or decrease? Will this stop the recovery in its tracks. Fed at moment is "puchasing" $85 bn in assets from banking system as traditional monetray policy is in "liquidity …

Will bank loans increase, or decrease? Will this stop the recovery in its tracks. Fed at moment is "puchasing" $85 bn in assets from banking system as traditional monetray policy is in "liquidity trap".

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  • 1. Effects of End of QEGlobal impact of a reduction in the $85/month bondbuying by Fed
  • 2. Housing – Finance Link—  Booms and bust transmit directly to banks and financialinstitutions;—  1973-1975 [UK-US]—  1991-2 End of S&L boom, insurers & banks in mortgages—  2006-2009 Repeal of Glass Steagall, disintermediation, alternativebanks originate distribute high LTV and subprime securitized loans.—  Nominal rates rise, to counteract INFLATION;—  BUT 2007-2009…. SOLVENCY CRISIS means interest rates haveto go down to almost ZERO in nominal terms, negative in realterms. Classic Liquidity trap, case study for economicsundergraduate course!—  Credit dries up. Loans from banks SHRINK money supply by over$1.0 trillion……..
  • 3. The Fed and QE
  • 4. Interest rate transmissionto real economy…—  Ration cash between today and tomorrow consumption/investment, [instant gratification];—  Prices at different times horizons, based on yield curve;—  Marginal Productivity of investment > 1;—  Low interest rates increase investment… But if there ismassive EXCESS capacity… then cash is hoarded;—  Wealth effect, lower rates, lower income from financialassets…. Increases net worth/liabilities;—  Currency depreciates, but can be offset by FDI.
  • 5. Because of credit default fear. Hard asset that can be movedeasily and retains its value.Why is Gold up?—  Gold price has been up dramatically
  • 6. $85 billion in bond and asset purchases per month 6US Fed Reserve
  • 7. Huge growth in assets as a result of bank bailouts.Bank of England—  Assets: (source: the Bank of England)
  • 8. Interest rate concepts—  Nominal vs. Real. In the real world there is no moneyillusion;—  Which inflation rate? Headline.. All “index baskets” areconstantly adjusted…—  Zero bound nominal rates… Deflation, liquidity trap..—  Yield curve changes affect saving investment horizions;—  Interest rates include a element of risk premium;—  Credit;—  Risk implied in asset returns….
  • 9. Risk transmission—  R = β[ 1 + Φ]—  R = risk adjusted rate;—  β= risk weighting;—  Φ = return on long term sovereign debt, assumed to be risk free.—  β=1 is risk neutrality;—  β>1 is risk aversion;—  β<1 is risk seeking, gambling…—  BUT!!!!!! This explanation breaks down when sovereign risk isnot risk free, as we saw in the Greek crisis…..
  • 10. Monetary Policy Impotence—  When 30 year treasury rates = 2.95%;—  Lending at banks shrinks by >$1.0 trillion, Fed takes up only 0.6 of slack;—  QE transmission out of US economy, in essence back stops growth in EMERGINGmarkets, not US;—  Unconventional monetary policy: Central bank can buy anything to create bankreserves, high powered money [H], [through money multiplier];—  EFFECTS OF QE:—  Lower yield’s across yield curve;—  Lower risk premiums ~ improving liquidity;—  Increase Wealth;—  Increase Ms and H. This can increase lending but really has not as corporationshoard cash, buy back shares.—  REAL ECONOMY GROWTH…. It is not happening fast enough……
  • 11. Hazard of large scale assets ofcentral banks—  International financial system stabilities, but isdrugged by Ms and H from Central banks;—  Financial assets bubble in the future? Or is it acrucial stop gap to prevent deflation… If so thefinancial system is inherently UNSTABLE (complextime lag);—  Changes US $ foreign exchange rates as reservecurrency and the term of trade.
  • 12. Food price index up—  Food price index has been up since 2007 (Source:Food and Agriculture organization of United Nation)
  • 13. China CPI and Food PriceChina CPI and Food price02468101214162010-012010-032010-052010-072010-092010-112011-012011-032011-052011-072011-092011-112012-012012-032012-052012-072012-09%CPIFood
  • 14. Does QE cause inflation?Printing money causes inflation only if the moneyis lent & spent …6.506.706.907.107.307.507.707.902008 2009 2010 2011 2012$trn0.00.51.01.52.02.53.0Money supply(right axis)Bank credit(left axis)Source: Gregory Ip, Economist. Shows the extent of bank solvency problem!
  • 15. … or if expected inflation rises-1.5-1.0-0.50.00.51.01.52.02.53.03.52008 2009 2010 2011 2012Expected inflationReal bond yieldSource Gregory Ip, Economist
  • 16. A lot of QE benefit swallowed upGap between mortgage rate paid by homeowner,and yield on mortgage bondSource: http://www.newyorkfed.org/research/conference/2012/mortgage/primsecsprd_frbny.pdf
  • 17. But seems to be workingSource: Gregory Ip Economist
  • 18. QE monetary policy effect on recovery—  High food prices and high gas prices degradesdeveloping country consumer confidences onthe future—  Appreciated currencies of emerging marketsand declining demand of the western marketsimpeded recovering economy of emergingmarkets—  Currencies appreciation/depreciation for $,Euro, Yen and C$ create new carry trades inthe recovery from this five-year recession
  • 19. Has QE worked? a measure of x:spread between corporate and Government bondsOnly in a temporary wayBut: In the long run..We are all dead!
  • 20. Conclusion—  Democracies in advanced are addicted to nominalgrowth, not real growth!—  Money supply has bought time for the adjustmentin living standards;—  Now it is up to developed world to create realeconomy wealth, and that is very difficult in todayseconomic environment;—  Banks role at center of developed economies willhave to change [= regulated], as have not been ableto fund growth, just asset bubble lending.