The Origin of QE Policy of Federal Reserve

Quantitative Easing (QE) monetary policy is the measure adopted by the central bank for injecting large amounts of assets to market aiming at generating new liquidity and encouraging consumption and investment at zero or close to zero benchmark interest rate, thereby stimulating economic growth. The main measure is that central bank buys national debt in large quantities in open market via printing paper money, enabling generated liquidity to enter the market, thus assets in market increase substantially. Its principle is that the central bank injects excess assets to bank system via open market operation to maintain zero benchmark interest rate, thereby creating new liquidity to economic system for encouraging consumption and investment, finally promoting economic growth and employment. The influence brought by QE policy is not only positive but only negative. For instance, the policy or economic activity of economic power America in worldwide scope has the certain influence to itself and even countries across the world, particularly in emerging economies including China. The influence generated by American policy or economic activity is greater. Facts show that America’s QE policy has the certain influence on other countries in the world.

Origin of QE policy of America

After the financial crisis in 2008, America implemented QE policy due to domestic economic sluggishness, high unemployment and shrinkage of credit and loan. The Federal Reserve expected to reach the objective of stimulating economic recovery via such policy, but it directly increased dollar depreciation expectation, large amounts of dollar investment assets entered emerging and developing economies for investment arbitrage, which brought serious impact to world economic stability. The main cause of implementing QE policy by America lies in the following points:

Malfunction of Traditional Monetary Policy, High Financial Deficit

After the outburst of the financial crisis in 2008, America plunged into its own economic problems. Money market rate stayed high after the outburst of crisis. Thus, the financing will of financial institutions decreased, and credit crisis broke out. Monetary policy regulation is the most direct mode, the Federal Reserve down-regulated interest rate consecutively. When the interest rate is regulated close to zero, the interest rate shall be unable to be lowered despite the increase of money quantities as interest rate cannot be lowered anymore (Joyce 19). As the main measure for regulating interest rate, the traditional monetary policy shall be malfunctioned then. However, when the interest rate is close to zero, the demand for cash shall increase. Thus, bank loan, private investment, and consumption shall be affected, possibly generating liquidity trap. Moreover, after the outburst of crisis, American government adopted an expansionary fiscal policy to cope with the incessantly deteriorating economic trend, such as expanding the investment of public sectors to promote demand. However, a series of expansionary fiscal policies let the financial deficit of America surge sharply. As per estimation, the public debt of America may exceed 100% of its GDP in 2025 and reach 185% of its GDP in 2035 (28). Therefore, continuously adopting expansionary fiscal policy may let financial deficit increase substantially and have the possibility of bursting financial crisis. Under the conditions of the better expansionary monetary policy and the malfunction of traditional monetary policy, non-traditional monetary policy, thus the QE had come into the stage.

Stimulating American Economic Recovery

The 2008 financial crisis forced American economy to enter depression stage. US GDP in the first quarter was USD 14,150.8 billion dollars and USD 14,294.5 dollars in the second quarter, increasing by 1.02%. Its GDP continued to increase in the third quarter, reaching USD 14,412.8 dollars, increasing by 0.83% as compared to that of the second quarter (Fawley 98). In addition, its GDP was USD 14,200.3 dollars in the fourth quarter, decreasing by 1.47% as compared to that of the third quarter. It can be seen from data that before the outburst of crisis, GDP growth slowed down; and its GDP experienced negative growth after the outburst of crisis. US unemployment rate was 4.91% in January, which maintained at about 5% until April. The unemployment rate increased obviously in May as compared to four months before, reaching 5.52%. From June to December, its unemployment rate increased to 7.19% (109).

Ben Bernanke explicitly pointed out that due to weak economic fundamentals, as well as high unemployment and excessively low inflation, the Federal Reserve needs to more stimulate the economy. The most inflation rate indicator was less than 2%, lower than the level needed by long-term sound economic growth in the minds of decision-makers of the Federal Reserve. Although low inflation is generally beneficial, when the economy is sluggish, excessively low inflation may cause serious risk to the economy (Kurihara 21). Under most extreme conditions, extremely low inflation may become deflation, which may cause long-term economic stagnation. The Federal Reserve expected to stimulate economy and employment within a short period of time due to pessimistic expectation on economic recovery, as well as the prevention and control on inflation or stagnation in advance.

Shifting Debt Crisis

Developed countries regard gold as foreign exchange reserve, and developing countries mostly regard dollar as foreign exchange reserve. US dollar depreciated substantially as compared to main world currencies from 2001 to 2006, and America’s accumulative external debt increased by USD 3.209 trillion dollars, but its net liability decreased USD 199 billion dollars. After balance, its net earnings during the same period were USD 3.408 trillion dollars, equivalent to 6 years of its total national defense military spending. ^[4] Ended the third quarter of 2010, as per the estimation of IMF, the worldwide foreign exchange reserve was USD 8.4 trillion dollars. Of which, the monetary category was USD 4.7 trillion dollars, and 65% was held in US dollar. In addition, by the end of 2010, its external total liabilities were close to USD 14 trillion dollars, one-third was held by developed countries, and two-thirds of holders were emerging economies and oil exporting countries (Blinder 221). It shows that large quantities of additional dollar issuance brought by QE policy of the Federal Reserve resulted in dollar depreciation, and the influence of such consequence to emerging economies is higher than that of developed countries. In addition, as the foreign exchange reserve of developed countries is mainly in gold, the gold value may increase relative to dollar depreciation. Thus, the loss suffered by developed countries shall be lesser. As to America, the dollar depreciated, and debt shrank due to additional dollar issuance, America imputed its debt risk to other countries, while developing countries became the main victims.

QE policy practice of the Federal Reserve sufficiently represented the coordination and match of fiscal policy and monetary policy, obtaining good policy coordination effect. The main representation lies in that: on the one hand, the Federal Reserve provided assets support for implementing expansionary fiscal policy via purchasing long-term national debts; reduced the cost of fiscal finance via lowering interest rate, and avoided excessive overflow of fiscal stimulation effect by virtue of currency rate regulation. The practice of the Federal Reserve adequately represented the role exerted by monetary policy in improving fiscal policy effect. On the other hand, the fiscal policy effectively prevented systematic financial crisis via purchasing non-performing assets of financial institutions and rescuing financial institutions on the verge of bankruptcy in capital injection mode, creating an excellent market environment for role exertion of monetary policy. Moreover, by virtue of providing a fiscal guarantee on non-performing assets, it alleviated the loss that may possibly occur due to the sales of non-performing assets, thereby reducing its financial burden in implementing exit policy, which is beneficial for strengthening the independence of its monetary policy. Furthermore, it improved the effect of implementing exit policy to recover market liquidity via expanding national debt issuance and depositing acquired assets to the Federal Reserve. The practice of US Department of Treasury shall be conducive to improving the implementation effect of the monetary policy of the Federal Reserve.