Quantitative Easing Paper

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Nov.06.2012
Ruixuan Ding
Corporate Finance
Quantitative Easing Paper
Introduction
United States confronted serious disorder in financial markets and steep declines in overall economic (Williams 2011) after 2007 financial crisis. The financial crisis in 2007 and its subsequent negative effects greatly challenge the conventional understanding of recession and available monetary policies to handle it. The US and global monetary authorities have been criticized for the excessively expansionary monetary strategies in last decade. (Giraud 2012). In this prospective, the monetary policy after the 2001 recession remained “too lax for too long and this triggered asset-price inflation” (Giraud 2012), not only in US housing but also in associated subprime mortgage. (Bernanke 2009) Especially, the huge amounts of housing mortgage defaults are unusual in formal recessions and deeply hurt investors’ confidence in credit market. The following nervousness about banking sector causes the economic slowdown and a credit crunch, which make more difficulties for business and household to go through the crisis. (Giraud 2012)

In order to fix the situation, several central banks, including the Federal Reserve (Fed), have decreased the market interest rate close to zero bound. (Williams 2011) Taking the lesson from Japanese experience from 2001 to 2006, (Giraud 2012) the Fed argued that under almost zero interest rate monetary policy still can be effective if implementing the unconventional ones, typically Quantitative Easing. Quantitative Easing (Q.E.) is also used in Eurozone and Japan as kind of panacea under this globally recession and Fed already announced the third round of Q.E (as Q.E.3). However, the actual effect and future forecast show that US economy is under uncertainty even after the third round of the Quantitative Easing. The cost and psychology of Q.E.3 tend to be permissive. The implement of Q.E.3, is largely overshadowed in current uncertainty. The high cost of the Q.E.3 as $40 billion monthly seems to be the only thing clear while the promised boost effect on both consumption and employment remained ambiguous. The other issue with Q.E .is not the inefficiency, but extra detrimental influences on US economics, especially on the currency value of US dollar. (Thornton 2010) The decreased value will risk its dominant role in global exchange and weaken the handle on possible inflation.

What is Q.E. & why is it used?
Quantitative Easing (Q.E.) is an unconventional monetary policy seldom introduced. (Blinder 2010) The unconventional monetary measure is deployed by central banks in response to deflation or extremely low inflation and a weakening economy when the conventional monetary policy is no longer effective (Lam 2011). A central bank like Fed, BoJ (Bank of Japan) and BoE (Bank of England) performs the Quantitative Easing by purchasing a mix of public assets such as government bonds and reliable private sector assets, such as corporate bonds and residential mortgage-backed securities (Stephen 2012) to inject the determined amount of cash flow into economy. It is differed from conventional open market operation that banks simply alter the amount of government bonds to adjust the interest rate. (Banerjee, Latto, McLaren 2012) The optimal outcome of the Quantitative Easing is that the new cash flow and lower interest rate finally stimulate the consumption and enhance the employment. (Williams 2011)

Quantitative Easing provides an alternative way for central banks to handle the financial shock while falling into the “liquidity trap”. The financial crisis usually brings out the negative effects on exchange and also reduces liquid interest-bearing assets. (Williamson 2012) In normal time, the conventional open market operation, or expansionary monetary policy, involves the central banks buying or selling bonds, supplying or subtracting reserves from the banking system, (Buhagiar 2012) in order to...
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