Home Business Economy What is ‘quantitative easing’ and can it help the Aussie economy?

What is ‘quantitative easing’ and can it help the Aussie economy?

Meet the controversial economic practice known as QE.

Jack Derwin

Digital Journalist, Your Money

iStock.com/Topp_Yimgrimm

The fields of economics and finance are riddled with complicated sounding terms and acronyms and perhaps none more so than ‘quantitative easing’.

So what is it and, as we go into a per-capita recession, can it save the Australian economy?

What is QE?

Quantitative easing, or QE, at its most basic level, means increasing the money supply swirling around the economy.

Under QE, a central bank, like our national Reserve Bank of Australia (RBA) for example, creates more money in order to buy government bonds and other securities from banks and other institutions.

These banks then find themselves with more capital than they need on hand and so, start issuing more loans so as to turn a bigger profit.

That money is thus injected into the economy via these cheap loans, further stimulating the economy.

The process ‘eases’ the quantity of available money, and is so named quantitative easing.

However, it is never used as a go-to economic solution. Rather, it is brought in when more conventional methods of economic stimulus, such as slashing interest rates (monetary policy) and increasing government spending (fiscal stimulus), have been exhausted.

In fact, QE requires a very low-interest-rate environment to work, in order to incentivise the extra money that is flowing through the economy to continue to be spent.

If interest rates were high and economic conditions poor, the temptation would be too great for individuals to leave their cash in bank accounts to accrue interest.

Where has QE been implemented?

Japan was really the first economy to pioneer the unconventional method between 2001 and 2006 and again after 2012.

The US then took the lead in 2008 after the global financial crisis (GFC), using QE to add nearly $2 trillion to the money supply – the single largest expansion in history.

The European Central Bank (ECB) then grabbed the baton in 2015, running with it until the end of 2018, albeit on a smaller scale to the US.

As Australia’s economy looks to continue to slow into 2019, entering a per-capita recession just last month, and with little room to cut interest rates further, it’s been suggested that RBA could even implement QE here.

What’s the problem?

So if three of the world’s most powerful central banks have run with QE to rescue their economies (with some success), what’s the problem with it?

Well, there’s a good reason that it’s considered more of an emergency effort by central banks than a proper solution.

QE’s injection of money can drive inflation higher without necessarily being supported by actual economic growth. This means that prices rise quicker than the economy does, with sometimes the economy even shrinking (stagflation).

The extra money swirling around the economy can push asset prices up, artificially inflating prices in some areas. Those bubbles can create other economic dangers as they threaten to pop and bringing prices crashing down again.

It also helps to devalue a country’s currency, as more available money decreases its value. That can help increase sales for a country’s exports but it also makes imports more expensive, driving up the price of production.

All of these weaknesses mean that economists are still split over the effectiveness of QE. Japan’s economy for example shrunk throughout its QE program, from $4.888 trillion in 2000 to $4.515 trillion in 2007.

Others like the US grew, but it remains difficult to conclude whether QE was responsible. In any case, what it did achieve wasn’t necessarily favourable.

“There are now plenty of studies that are showing that QE in the [United] States and also in Europe helps one group of people but not the overall population,” InvestSmart chief market strategist Evan Lucas told Trading Day.

The use of debt to drive up asset prices means it only really benefits those who own assets, like property, for example, Lucas explained.

“If you’ve got assets…you have benefited from the QE process [but] if you are income positive but asset negative you’ve actually gone nowhere since the GFC.”

In that way, it can make the rich richer and disadvantage those who now may be priced out of buying assets.

So, would it work in Australia?

While central banks overseas have implemented QE programs before, Australia’s avoidance of a recession in the wake of the GFC mean it’s never been tried here.

But that doesn’t mean the RBA wouldn’t, with Lucas believing that it’s under consideration.

“You are starting to see the signs that we [could] go through the process: we’re cutting rates, [if] we hit a recession, QE is on the table in Australia,” Lucas explained.

After the Australian economy entered a per-capita recession, however, it’s clear that the problems plaguing it require a different kind of medicine, according to Lucas.

“Business investment is going backwards again. Non-mining was looking like it was going to pick up that slack and now it’s gone backwards again, and that is the concern,” he said.

Productivity needs to be looked at [and] productivity, therefore, means structural fiscal reform and policy reform that actually allows business to have the confidence to do things into the next decade.”

With slowdowns in certain sectors, such as retail and construction, there are certainly challenges ahead for the Australian economy.

In that case, would QE achieve much in Australia?

“Yes, QE would help. It would certainly stop asset declines, but would it actually do the job it really needs to which is to target that very structurally low consumption issue?”

“That’s the conundrum.”

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