QE refers to an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. Quantitative easing is considered when short-term interest rates are at or approaching zero, and does not involve the printing of new banknotes.
Reasons:
- Like lowering interest rates, QE is supposed to stimulate the economy by encouraging banks to make more loans.
- Raises stock prices and lowers interest rates, which in turn boosts investment.
- can also boost economic activity by raising confidence.
QE by USA: Several rounds of QE in America have increased the size of the Federal Reserve’s balance sheet—the value of the assets it holds—from less than $1 trillion in 2007 to more than $4 trillion now.
QE by EU: European Central Bank (ECB) launched QE in March, 2015 –> Its monthly purchases will rise from around €13 billion ($14 billion) to €60 billion until at least September 2016.
The resorting of Central banks to unconventional monetary policies to ward off recession and deflation has caused serious problems for Emerging economies like India. In the light of the Fed Quantitative Easing followed by latest
decision of the EU critically examine how such policies impact India? (200 Words)
The use of quantitative easing is a last resort when interest rates are already set near zero percent. It is why quantitative easing is an unorthodox monetary policy since central banks will only perform quantitative easing when all other options are not helping the economy.
Concerns for the CIS, BRIC, and other emerging economies is related to how the globalized nature of the international economy and actions by the United States or the European Union impact the emerging economies.
The effects of such QE would be :
- In general, financial firms that are now free to lend will rush their investments into the emerging economies. This is because there is a higher rate of return on investments in emerging countries compared to highly developed countries like the United States.
- An increase of local inflation. As more foreign currency enters into a country, like a CIS or BRIC country, the local economy reacts with inflation since more money, foreign or domestic, is available in the local market.
- Local currencies could be devalued. With the quantitative easing cheaper, other countries react by devaluing their currencies so their exchange rates are lower. This can cause a global currency war, resulting in large scale, impaired economic growth since citizens will be unable to purchase many goods or services.
- Moreover, the money that will come in will be “hot money“ and such investments are very volatile and short term. Hence their later withdrawal from the economy will lead to spiraling down of the local currency.
- Due to the unfavorable and fluctuating market, investors will be skeptical to invest in the stock markets.
- The EU is India‘s largest trading partner and this will hit the Indian exports to the EU badly
If the nations of the European Union are not careful with the amount of quantitative easing they perform, it will have dire consequences around the world. The European Union and others need to solve their economic problems, but if they are not careful, their solutions will seriously harm other nations and plunge the world deeper into economic turmoil.