The first round of QE in 2009 essentially served the purpose of stabilizing the economy; the second round is intended to sustain the ongoing economic recovery by providing sufficient capital in the system that the positive momentum generated in the economy will eventually become a feedback loop of its own that results in the restoration of GDP growth and a reduction in the unemployment rate.
To analyze the effectiveness of this strategy, the case of Japan can be analyzed. The Bank of Japan's QE policy, which was aggressive in nature, resulted in creating strong liquidity in the Japanese economy. Market expectations of inflation were impacted as well. However, the Japanese experience did not result in improving job creation. In these Japanese experience, the stimulative effects of quantitative easing did not extend beyond the stabilization of the financial sector, "suggesting that the transmission channel between the financial and non-financial sectors had been blocked" (Shiratsuka, 2010). In the United States the most recent round of QE, which is ongoing, is timed at a point when recovery has already been stimulated by fiscal policy, with the objective of maintaining momentum that already exists. The Japanese experience did not have this momentum, so the impacts of the QE were less successful at addressing the nation's unemployment rate. The Japanese experience tells us that the timing of the QE is important, because there needs to be efficient flow of capital through the intermediaries into the economy in order for the policy to create jobs.
Export Costs
One of the most important impacts of a quantitative easing program is the effect that it has on the value of the currency. By increasing the supply of money in the economy, the currency is effectively devalued. This strategy works in particular when the business cycles of the economies in question are not synchronized. If the business cycles of the countries are closely synchronized, then the positive impacts resulting from exchange rate devaluation are limited. When business cycles differ, there is opportunity to spur exports by lowering the exchange rate. As quantitative easing has the impacting of devaluing the currency, it becomes a mechanism to lower the exchange rate (Borio, English & Filardo, 2003). Thus, the U.S. dollar should be lowered against major world currencies as QE is implemented, improving the competitiveness of exporters. Of particular interest is the impact of QE on the dollar-yuan exchange rate. As the Chinese government attempts to combat a rise in the yuan's value, its task is made more difficult by quantitative easing, putting additional pressure on China to allow the yuan to appreciate, a move that would help the U.S. trade balance but would do economic harm to China (Feldstein, 2010).
Criticisms
There appear to be two primary criticisms of quantitative easing. The first is that the policy is unconventional, and therefore should not be used. While it is true that QE is a little-used instrument of monetary policy, it is not so unusual that it should not be tried. This objection does not reconcile with the fact that the Federal Reserve has a number of different tools at its disposal to implement monetary policy, of which QE is just one. The characteristics of the U.S. economy at present -- and especially last fall -- are that of a classic liquidity trap in which zero interest rates are insufficient to produce full employment (Krugman, 2000). This implies that conventional monetary policy in the form of lowering interest rates has already been attempted and is insufficient. It is in this context that quantitative easing is normally used, the classic example being Japan in the late 1990s.
The second criticism of quantitative easing reflects the risks inherent in the strategy. The strategy is criticized for achieving precisely what it intends to achieve -- increasing inflation and devaluing the currency. The currency devaluation argument is usually only conducted on moral grounds -- that devaluing the currency is bad because it is. The economic case for devaluing the currency is apparent from the basic GDP accounting identity: GDP = C + I + G + (X-M). At times when quantitative easing is typically attempted C. And I have not been sufficiently stimulated by interest rates at the zero bound. Fiscal policy has either been proven ineffective or is for one reason or another political infeasible. This leaves X-M as the sole remaining way of improving economic prospects. There are mechanisms by which the balance of trade can be impacted, but many such mechanisms either fall within the realm of...
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