Quantitative Easing (QE) was a rarely used in the 20th century but in recent years it has come into the limelight. QE involves the government purchasing bonds and similar securities, from either institutions or the open market, to inject money into the economy and to stimulate growth and inflation. As interest rates started to near the Zero Lower Bound (ZLB) and even become negative in some countries, the central banks had to resort to QE because reducing the interest rates to stimulate growth was no longer an option.
Till date, QE remains a heavily controversial and highly debatable monetary measure. This is beautifully expressed by Ben Bernanke as he says (Haldane, 2016), “The problem with QE is that it works in practice, but it doesn’t work in theory.” In this research paper, we have evaluated the effectiveness of the policy over two instances – the USA (2008) and the UK (2016). The United States QE of 2008 was executed to support the economy after the Financial Crisis while the UK carried out QE in 2016 to control the economic turmoil caused by the announcement of ‘BREXIT’.
We performed a qualitative and quantitative analysis to measure the impact of QE. Based on these results, our model makes an implicit assumption that money supply increases as a result of QE. Based on this assumption, we measure the impact that the increase in money supply has on the following variables:
- Short-Term Interest Rates
- Long-Term Interest Rates
- Inflation (Consumer Price Index)
- Unemployment Rate
A Vector Autoregressive (VAR) model was used to analyse the response of the aforementioned variables to QE.
The following reduced-form VAR model was used to estimate the impact of QE:
Y_t=A(L) Y_(t-1)+c+ μ_t
Where, Yt-1 is a matrix of the lagged values of the variables, A(L) is the vector of autoregressive coefficients, c is the intercept term and is the vector of residuals.
Impulse response functions were used to analyse the impact of QE on the macro variables post-QE. The results of the modelling exercise were as follows:
Short-term interest rates initially decrease, followed by an increase as rates finally stabilise as the time horizon gets longer. The overall effect is one of a decrease in rates.
QE seems to have a mild impact on longer-term interest rates. In the aftermath of the unconventional policy, we observe that there is a decrease in the long-term interest rates, this effect dwindles in the medium and long run.
QE has a negligible impact on the rate of unemployment and affects this variable the least out of the ones considered in this model. Despite this policy measure, unemployment rates continue to increase in the short and medium term. However, in the long run, the rate stabilises due to various other measures taken by the government.
In the short term, QE has an undesirable impact on inflation, and this shows that it does not immediately impact the demand and consumption drivers behind the economy. A reversion to the mean and a further upward trend in the long run signals that QE has the desired effect although it takes some time for the economy to adjust to this greater influx of cash.
Being an unconventional monetary policy, QE has always been looked at with a pinch of disdain. As outlined in our paper, the temporary and short-term nature of the policy has been criticised by economists. However, we must acknowledge that these asset purchases have seen some form of success given their increased adoption across the globe. An economy is a dynamic machine, that has ever-changing inputs and numerous variable outputs which also react to public and political sentiments that are near impossible to quantify. Hence, isolating the effect of a particular policy becomes extremely difficult.
Finally, we conclude that QE is effective in times of crisis. However, it is not a magic pill that rids the economy of all its financial illnesses, but rather a painkiller that aids in the process to recovery and provides short-term relief