By Dr. Chao Yuang Shiang
(Assistant Professor, Dep. of Finance and Institute of Financial Management, Nan Hua University)
IV. Economic Impact Analysis
Quantitative easing may cause higher inflation than desired if the amount of easing required is overestimated and too much money is created by the purchase of liquid assets.
On the other hand, QE can fail to spur demand if banks remain reluctant to lend money to businesses and households. Even then, QE can still ease the process of deleveraging as it lowers yields. However, there is a time lag between monetary growth and inflation; inflationary pressures associated with money growth from QE could build before the central bank acts to counter them.
Inflationary risks are mitigated if the system's economy outgrows the pace of the increase of the money supply from the easing. If production in an economy increases because of the increased money supply, the value of a unit of currency may also increase, even though there is more currency available. For example, if a nation's economy were to spur a significant increase in output at a rate at least as high as the amount of debt monetized, the inflationary pressures would be equalized. This can only happen if member banks actually lend the excess money out instead of hoarding the extra cash. During times of high economic output, the central bank always has the option of restoring reserves to higher levels through raising interest rates or other means, effectively reversing the easing steps taken.
Increasing the money supply tends to depreciate a country's exchange rates relative to other currencies, through the mechanism of the interest rate. Lower interest rates lead to a capital outflow from a country, thereby reducing foreign demand for a country's money, leading to a weaker currency.
This feature of QE directly benefits exporters living in the country performing QE, as well as debtors, since the interest rate has fallen, meaning there is less money to be repaid. However, it directly harms creditors as they earn less money from lower interest rates. Devaluation of a currency also directly harms importers, as the cost of imported goods is inflated by the devaluation of the currency.
Neil Irwin wrote in The New York Times in October 2014 that the QE programs of the U.S. Federal Reserve likely contributed to:
- Lower interest rates for corporate bonds and mortgage rates, helping support housing prices;
- Higher stock market valuation, in terms of a higher price-earnings ratio for the S&P 500 index;
- Increased inflation rate and investor's expectations for future inflation;
- Higher rate of job creation; and
- Higher rate of GDP growth.