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".
Effects of End of QEGlobal impact of a reduction in the $85/month bondbuying by Fed
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……..
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.
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
$85 billion in bond and asset purchases per month 6US Fed Reserve
Huge growth in assets as a result of bank bailouts.Bank of England Assets: (source: the Bank of England)
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….
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…..
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……
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.
Food price index up Food price index has been up since 2007 (Source:Food and Agriculture organization of United Nation)
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
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!
… 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
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
But seems to be workingSource: Gregory Ip Economist
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
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!
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.