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FOREIGN REPORTFOREIGN REPORT
Not Able to Exit from Quantitative Easing
Kim Na Young  |  nykim1226@korea.ac.kr
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승인 2013.10.31  13:02:16
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“By increasing the number of the United States (U.S.) dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

– Ben Bernanke, Chairman of Federal Reserve 

 

   
▲ The building of the Federal Reserve Bank in Chicago. Provided by http://www.panoramio.com

As Ben Bernanke, a chairman of Federal Reserve Bank (FRB), has mentioned about how continuously producing U.S. dollars may lead to a “positive inflation,” the FRB stated, rather surprisingly, that they would maintain quantitative easing at the same level by printing $85 billion per month on Thursday, September 19, 2013. To be more specific, 40 billion dollars was for mortgage-backed securities and 45 billion dollars was for U.S. Treasuries. This was some especially shocking news, as Bernanke had previously hinted that the FRB is planning to “step down” on the current Quantitative Easing (QE) policy and reduce the amount of dollars produced each month. As a result of such striking a announcement, the entire world, including the U.S, has started to become noisy.

 

Quantitative Easing for Economic Easing

The term QE refers to a situation where a country lowers its interest rates close to zero and releases newly printed money to the economy. The aim of such an irregular policy is to regulate the economy so that it can find its way and flow better. By increasing the money supply within the country’s economy, the government and the central bank aims to save the economy by buying governmental bonds, and encouraging investing in many different companies, and stimulating the family household consumption.

 Such an irregular and untraditional policy unfortunately has various disadvantages, as it disturbs the flow of the economy. The greatest detriment it leads to is that if QE is continuously maintained, it may cause inflation, since the constantly released money would lead to sharply rising prices. It may also be a factor that leads to stagflation, if the prices dramatically rise without solving much of the economical price problems.

   
▲ Bunches of newly printed U.S. 100 dollar bills. Provided by http://www.rferl.org

In order to prevent such side-effects, the country has to pursue an Exit Strategy, which is a method used to decrease the money supply of the country’s economy. Usually, this is done by increasing interest rates back so that many investors would save their money in their banks rather than on companies or other developing countries. Such strategy is undoubtedly necessary in order to settle the economy back to normal, but the U.S. has not yet decided upon when to carry it out.

 

QE1, QE2, and QE3

The current Quantitative Easing policy where the U.S. increases the money supply by printing and releasing 85 million dollars per month has first been declared and put into action on September 13, 2012. However, this was not the first time the U.S. has decided to control the money supply through such economic policy.

The first QE policy, which is often referred to as QE1, occurred between November 25, 2008 and March 31, 2010 due to extremely low employment and economic growth rate. Such policy was undertaken in order to alleviate the economic problems that were apparent during the 2008 global crisis. At an early stage of such a method, the FRB had launched a program which would print about 600 billion dollars per month. In March 18, 2009, it was even expanded to 1.25 trillion dollars. Fortunately, at that time, QE1 was considered as relatively successful in mitigating the crisis.

 The FRB declared the second QE policy known as QE2 on November 30, 2010, as the U.S. saw the European debt crisis and felt the need to take action. This time, by focusing on decreasing the amount of national debt, as it was considered to be The Age of Deleveraging, the policy was carried out in a comparatively smaller and less influential size. It also did not last even a year, as it had ended on June 30, 2011. In the short-term, QE2 appeared as if it had effected the U.S. economy positively, but looking back today, it did not actually improve the economy very much.

   
▲ Ben Bernanke, the chairman of FRB, speaking in public.Provided by http://nytimefederalreservedearjohns.com

 On September 13, 2012, QE3 was officially undertaken in order to reach the point where the American economy would be self-sustainable. This is the QE policy that is carried out right at this moment by the U.S. Unlike QE1 and QE2, however, the specific date on when this would end has not yet been decided.

 

Shut Down of Exit Strategy?

There is unfortunately some bad news for the U.S. On the late evening of September 30, 2013, federal agencies and most governmental officers were ordered to shut down from the next day for the first time in 17 years. This means that they have to have a compulsory unpaid vacation, since the government is not able to pay their salaries. Even President Obama has cancelled all of his plans of visiting different countries in Asia due to the shutdown. The reason was that the budget proposal had been rejected, due to the disagreement between the Democrats and the Republicans.

As a result of this situation, many experts are viewing that this would lead to serious damage of the U.S. economy. In fact, Professor Sohn Sung Won of California State University has stated that “this shutdown would most definitely lead to a downfall of the U.S. rate of economic growth.” The IHS Incorporated has also announced that the shutdown would cost the U.S. at least 300 million dollars a day. Thus, even if the shutdown ends quickly, it is clear that it would have severe negative consequences on the economy as a whole.

Such economic chaos in the U.S. would most likely have an effect on the QE policy of the U.S. as well. It is because in order to regulate the economy so that the situation can be alleviated, the QE policy needs to be maintained for a few more months, as the policy is aimed for a better economy. This means that the Exit Strategy cannot be carried out for a while.

 “There is definitely not a high possibility that the U.S. and the FRB would start decreasing the importance of the QE policy this year. In order to make up from the negative effects of the shutdown and the problem of the debt ceiling, they would have to maintain it for at least a few months. Thus, this would naturally lead to Fed deciding upon the end of QE3 next year,” adds Professor Sohn.

             

Maintenance of QE3 – Hope or Crisis?

When the news of the Fed Reserve announcing their plan to maintain QE was first aired, many of the developing countries in the world screamed hopefully. It was because they were worried about the effects that they may get from the Exit Strategy if the U.S. had decided to put an end to QE, based on their past experiences with QE1 and QE2. As Temasek, an investment company in Singapore had stated, “the Exit Strategy of the U.S. is a crisis to the economy of the developing world.”

The reason for this is simple. If the U.S. proceeds with the Exit Strategy instead of QE, it is likely that the Fed Reserve would stop purchasing bonds, and would increase the mortgage rates. This would mean that the dollar liquidity in the world economy would decrease and many investment companies worldwide would withdraw from the dollars they had put into potential companies in the developing world. Since many of such countries’ economies are based on those investments, it would have to suffer some damage. Since the maintenance of QE means no Exit Strategy, it is obvious that such developing countries are delighted by such announcement.

There are also views that the decision by the U.S. to delay the Exit Strategy was a good choice because it would help the developing countries to minimize the negative influence they might get from such a policy. “In my opinion, I think that the U.S. made the right choice to maintain QE for a little more because it gives the developing countries more time to actually be ready for the possible downsides that may occur,” says Lee Jun Min (’13, Economics)

   
 

However, among experts, it is generally agreed without much doubt that QE3 needs to be ended sooner rather than later, as it would nonetheless cause too much negative consequences on the U.S. economy. “The fact that his untraditional method of QE is continuously sustained for a long period of time is causing new concerns about excessive liquidity,” says Lim Chuljae, the Head of Payment Systems Management Team of Bank of Korea (BOK). “As the excessive liquidity has a high possibility of ultimately leading to inflation, it is also very difficult to be maintained in the long term. If the general public starts to lose faith in the Central Bank about controlling the inflation, it would negatively affect the expectations of them, and would most probably result in hyperinflation.”

Some people may think that holding on to QE for too long would only affect the economy of the U.S. severely, but this is wrong. Since the U.S. is one of the main economies of the world and the U.S. dollar is the key currency in the international economy, the collapse of the U.S. economy would likely affect the economies of other countries as well.

Thus, although the U.S. maintaining the QE policy for a longer time, possibly until the beginning of next year, may seem hopeful for many of the developing countries in the short term, in the long term, it can rather be viewed as a crisis.

 

Handling the Policy

Since the U.S. has declared to maintain QE and is likely to continuously keep it until the beginning of next year due to the recent shutdown, it is undoubtedly crucial for them to decide upon how to regulate such policy to make it work the best.

It is not only the U.S. that has to handle with the policy; it is also necessary for other countries to think of better ways to cope with it. Although any people do not regard Korea as a developing country anymore, it is still true that it may also get some negative influences, if the U.S. declares an end to the QE policy. “Since Korea has a sound macro economy, including growth, price, and balance of international payments, raising the resiliency to foreign impacts by maintaining such an economy is important,” suggests Lim.

The Exit Strategy may also cause problems of rapid in and outflow of capital. This would lead to great confusion within the country’s economy. As a way to prevent this, Lim suggests that “the country should flexibly use and apply macro-prudential policy means in the foreign exchange section such as a forward position limit and a macro-prudential stability levy.”

It is obvious that many developing countries would be influenced by the U.S. and its maintenance of the QE policy. Thus, it is necessary for such countries to handle and work with the policy. This means that it is not the time for them to celebrate, but time to prepare well for the Exit Strategy of the U.S, as the day that the U.S. ends QE is inevitable.

 

 

 

 

 

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