Quantitative Easing Monetary Policy (Essay Sample)

Quantitative Easing Monetary Policy
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Quantitative easing is a monetary process used by a central bank to inject money directly into the economy. The money is obtained through purchasing of existing bonds and other government securities with an aim of lowering the interest rates. Once the central bank has purchased government and corporate bonds, the revenue is credited to investors which increase the liquidity of such bonds. The proceeds are received by banks which in turn improve their lending capacity. The net effect is an increase in the money circulating in the economy. The policy is important in hard economic times particularly during the Covid-19 pandemic which has contributed to job losses, collapse of businesses and general economic depression (Lenza & Slacalek, 2018).
Figure 1:Process of quantitative easing
An example where this policy was applied is the Bank of Japan in the year 2001. The same policy was applied on March 15, 2020 following the economic shutdown attributed to Covid-19. The United States Federal Reserve initiated quantitative easing plan of over 700 billion dollars.
While it is beyond the scope of this paper, we will adequately discuss quantitative easing as a monetary policy and its effects on all stakeholders of the economy. Basically, a monetary policy will affect all households and firms, financial institutions and the government. The technique has been used by Central Banks in many countries. Some of the big Central Banks having lately used the policy include Federal Reserve Bank, Bank of England, European Central Bank and the Bank of Japan. There are obviously pros and cons to the use of this policy. The benefits are as follows.
Low bank lending. People might mistakenly believe that by filling banks with reserves, it encourages lending out the excess. Such is not the case. Banks do not require excess reserves to lend to their clients and firms (Hohberger et al., 2020).
The interest rates for loans are lowered in the short run. By increasing the monetary base, the interest rates tend to lower as there is more money in the circulation. This is an advantage to firms and households as they can access the funds more easily. The policy drains unnecessary assets. In cases of subprime mortgages, toxic assets are bought by the government using the same policy. This expels such assets out of the system awaiting attainment of the equilibrium where the assets can be slowly absorbed back to the system.
Despite the advantages, the policy has been heavily criticized by top economists all over the world due to the following setbacks of the unconventional process.
Increase in money supply by the can cause inflation. A worse scenario is where there is not simultaneous economic growth which is the main intention. Critics of this policy often point to injecting liquidity into the economy which they associate with an obvious inflation. This, however, depends on the state of the economy. This can however be prevented by reversing the process. This will be accomplished by selling the assets back into the banking system;
Effect on interest rates. In the short run, the policy causes a fall in the interest rates but long-term effects are associated with inflation which raises the interest rates.
Quantitative easing is associated with creation of business cycles. Since it brings money easily into the economy, the finances land into institutions which are then desperate to lend the money. This leads to loss of credibility among borrowers and unnecessary lending. In the long run after stoppage of the process money loses liquidity and businesses start contracting. This creates a cycle of recession and boom. Economists call this unpredictability (Huston, & Spencer, 2018).
 
Critics of this policy point on the resource redistribution created by quantitative easing. Former British Prime Minister Theresa May, for instance criticized the monetary policy for helping the rich get richer at the expense of the poor. Anthony Randazzo working for the Reason Foundation also held the same views pointing to the fact that it was a regressive redistribution as it caused income inequality by increasing wealth to the people who are already financially strong while passing little to the rest. The criticisms are supported by evidence from the Central Bank of England report. Federal Reserve Bank of Dallas in the United States also confirmed that cheap money has made rich people richer while doing little to the economy.
Quantitative easing can also have a serious effect on Foreign exchange rates. By purchasing long term bonds and assets, the supply of one currency changes relative to the others. The ultimate result is similar to buying other currencies leading to manipulation of currency value (Rudebusch, 2018).
 
Another important drawback of the policy is its effect on the pension funds. It hits pension funds since the government uses bond prices to estimate how much pension it will pay in future. The pension cost, therefore, rises if the bond prices increase. As a result, firms are o