‘Unconventional’ is probably a misleading label for QE, given the extent to which it has been used since the global financial crisis (GFC). This is clear in the expansion of central bank balance sheets. For some banks the expansion is ongoing and is now part of their normal activities
QE is thought of as an unconventional tool called on by central banks when the usual policy – of cutting short-term interest rates, typically the overnight cash rate – has reached its ELB. Just where the ELB is varies across countries.
Some countries have waited until the overnight rate was negative before considering QE, while others have turned to QE while cash rates are still positive. The US Federal Reserve turned to QE when the federal funds rate fell to a 0 per cent to 0.25 per cent range.
QE attempts to influence the economy in a number of ways. Central banks buy bonds using funds from balance sheet expansion. The sellers of government bonds receive cash, which they then spend – often on other assets.
This additional demand drives up the price of these other assets (whether they be equities or other fixed-income assets such as credit). Some of the cash may also flow into consumption spending. The central banks’ demand for bonds also drives down the interest rates on those bonds. This encourages funds to flow to areas promising higher returns.
Lower interest rates are also expected to generally lift asset prices, with the value of a given cash flow more valuable when interest rates are lower, and encourage consumption as the return from delaying spending falls.
Does it work?
QE has certainly had an impact on interest rates, as the case of Japan makes clear. In turn lower interest rates have impacted the value of other assets, such as equities, commercial property and housing.
Indeed, the impact on asset prices is often used as a criticism of QE, because the rise in asset prices is seen as benefiting some at the expense of others.
In terms of the broader macroeconomic impact of QE, or more specifically of the unconventional monetary policy employed in recent years, the BIS published the research paper Unconventional monetary policy tools: a cross-country analysis.
Dr Lowe is Chair of the committee that released the report. In the preface he notes the report concludes “on balance, (unconventional monetary policy) helped the central banks that used them address the circumstances presented by the crisis and the ensuing economic downturn.”
The overall message is that unconventional monetary policy tools (UMPT) helped the central banks that deployed them address the circumstances presented by the crisis and the ensuing economic downturns. Despite the challenges these instruments pose they are valuable additions to the central banking toolbox.
The assessment of central banks is UMPTs were effective in both these objectives - but they also have their limits. The effectiveness is significantly enhanced when deployed in the context of a strategy that encompasses other types of public policy, in addition to monetary policy, in order to mitigate their side effects and boost their effectiveness.
Often the discussion around the impact of QE and other UMPTs focuses on what has happened to interest rates, asset prices and so forth. But it must be remembered that these are not an end in themselves.
It is the economic impacts of lower interest rates, a lower currency and higher asset prices that really matter. The conclusion of the research is these economic impacts are positive, i.e. growth is higher and unemployment lower than it would have been in the absence of these tools.
Some key lessons can be drawn from the international experience of QE. These include:
• the effectiveness of these measures depends upon the specific economic and financial conditions facing each economy at the time, as well as the structure of its financial system;
• the measures have been effective in cases where there had been severe dislocations impeding the supply of credit;
• QE has been successful in lowering government bond yields, which in turn lowers interest rates across the economy for private borrowers, since government bond yields are the risk-free rates underpinning all these interest rates;
• a package of measures that reinforce each other tends to be more effective than measures implemented in isolation; and
• it is important for central banks to communicate clearly and consistently about the unconventional measures when they are implemented.