If you’ve opened a Financial Times or a Wall Street Journal lately, you’ve probably encountered the term “quantitative easing.”
First practised by the Japanese central bank in 2001-2006, this radical step in monetary management has now been taken in the last few months by the US Federal Reserve, the Bank of England, and the Swiss central bank, while the Bank of Canada prepares to join in. Of the world’s major central banks, only the Frankfurt-based ECB is so far sitting on the sidelines, preferring to use more traditional means of monetary policy.
What exactly is quantitative easing (“QE”), and how will it affect investors in different categories of ETFs?
QE is a policy step undertaken by central banks when they become concerned that interest rate cuts may not be working, or when rates are already at such a low level that further cuts are effectively impossible. The rationale for the policy was set out in a 2004 speech by the current US Federal Reserve Chairman Ben Bernanke, perhaps the chief ideologue for the QE movement.
“The public might interpret a zero instrument rate as evidence that the central bank has ‘run out of ammunition’… ,” said Bernanke. “[T]hat would be a misimpression, as the central bank has means of providing monetary stimulus other than the conventional measure of lowering the overnight nominal interest rate… [P]olicymakers are well advised to act pre-emptively and aggressively to avoid facing the complications raised by the zero lower bound.”
QE involves the central bank buying assets from private banks. Usually, the bank will focus its purchases on government and corporate bonds, but it can in theory buy anything, even equities. This transfers money to the banks’ balance sheets. The intention is for the central bank to resell these assets at some point in the future, but there is no fixed date for this to occur.
The newly-created money—base money, in economics parlance—is supposed to help stimulate lending in the economy through the effect of the “money multiplier”: since banks are typically required to keep the level of overall loans at a minimum fixed multiple of their reserve assets, the more reserve assets they have, the more they can lend.
It’s fair to say that the ultimate outcome of the QE experiment is highly uncertain. Even the results in Japan, which started it eight years ago, are still hotly debated. Many argue that QE had little discernable effect in helping the Japanese economy recover; Western policymakers counter that Japan adopted QE too late in its downturn to have the desired results.
This explains the prompt and coordinated introduction of the policy in recent months, occurring very soon after interest rates had been slashed, a tactic that was clearly flagged in Bernanke’s speech.
The most vocal critics of QE argue that, in an economy suffering from excessive debt levels, where market participants want to reduce their indebtedness, QE will be ineffective, as no one will want to borrow all the newly-created money.
In addition, the introduction of the policy threatens the world’s central banks with possible losses from their market operations, which will have to be met by the taxpayer. QE also places the central bank in a more active fiscal (and therefore political role), something with major implications for the balance of power between policymaking institutions.
These reservations aside, it’s fair to say that the consensus amongst economists is that QE will help the economy to recover, and there have already been some sharp moves in markets as a result of its introduction. How have these been reflected in some key exchange-traded fund sectors, and what is the likely future impact on prices from QE?