Global Impact of ‘Quantitative Easing’ pursued by Developed Economies: A Retrospective View

Of late, the term ‘Quantitative Easing’ has been one of the most discussed topics in the financial media circle. So, what is this Quantitative Easing? Why is there such a big hype about it in financial circles? Though ‘Quantitative Easing’ is a complex topic let us discuss the underlying basic principle in simple terms.

What is Quantitative Easing?

‘Quantitative Easing’ is a financial policy that is employed by a country’s central bank to increase liquidity in the markets and in turn boost the growth of the economy. To achieve this, the central bank will infuse cash into the economy by purchasing assets from all the major banks and financial institutions in the country. This will essentially provide a cash surplus to banks that are suffering from a credit crunch.

Now, these banks can lend this surplus money to cash-strapped borrowers in the economy. Since borrowing is made easier the interest rates will drop, causing consumers to spend more and businesses will start thriving again. As per the economic theories, increased spending means increase in consumption, which will in turn fuel the demand for goods and services. This results in an increase in production, creating more job opportunities. Ultimately, the intended result is to revitalize the ailing economy of a country.

Why was Quantitative Easing employed in Developed Economies?

Due to the global financial and economic crisis of 2008, the leading economies of the western world went into a deep recession. This caused the unemployment rates to soar and industrial growth to languish. Many countries in the world adopted a slew of stimulus packages in a bid to revive their ailing economies. Among them is Quantitative Easing policy.

So, the major western economies like USA, U.K, the Euro Zone, and Japan employed Quantitative Easing (QE) with the intention to reboot economic growth by increasing liquidity. But, this QE, apart from affecting their own economies, also started to have a ripple effect all over the globe. This affected many emerging economies in the Asian world.

During the financial crisis, apart from the major western countries, many emerging economies too employed QE like policies to prop up the demand for goods and services in their fluctuating economies. While these emerging economies seem to have overcome the crisis with bright prospects of economic growth, the same is not the case with the major western countries.

The major western economies especially are still battling with a sluggish economy, declining industrial output and modest improvement in their unemployment reports. This has forced them to persist with their QE stimulus packages to create more demand in their market and attempt to stimulate growth in their declining industrial outputs.

Most of the major western economies have increased their QE-phase cash infusion to larger doses, as part of their third round of stimulus. As a result of the previous two rounds of Quantitative Easing policies, the U.S Federal Reserve has increased its Treasury notes to 2.054 trillion dollars. Whereas, the Fed’s Treasury notes amounted to a mere 700 to 800 billion dollars before the recession set in. With the current unemployment rate still around 7.6%, the US Federal Bank plans to further purchase around 40 billion dollars of mortgage-backed securities per month until unemployment rate declines below 6.5 percent.

On the other hand, the European Central Bank (ECB) is reported to have pumped around 489 billion euros into the Eurozone, in an effort to prop up the collapsing economies of many member countries. Meanwhile, the U.K’s QE policy is reported to have infused liquidity to the tune of 375 billion pounds to revive its ailing economy. Lately, Japan struggling with fluctuating markets and stagnant economic growth has decided to pump a further 1.4 trillion dollars into its economy over the next two years.

All of these economic stimulus packages have created a flood of liquidity in the western economies and markets. But, with market sentiment dull in the western world, what with gloomy economic forecasts and near zero interest rates; it inevitably caused huge capital outflows towards other more promising economies.

Effect on Emerging Economies

The emerging economies were having moderate growth and bullish markets during that time. So, the western financial institutions invested huge capital in these markets to take advantage of the better returns and interest rates. Though this provided huge capital inflow to the emerging economies like Asian countries, it also inflated the debt in the balance sheets of their companies.

The Asian companies kept increasingly borrowing the foreign capital that flowed from the major western economies operating in their QE-phases. This has made these Asian companies that previously had healthy debt to equity ratios, more risk prone and vulnerable. This has placed them in a precarious position where they are now vulnerable to future changes in interest rates in the major western economies and other western countries. This foreign capital inflow also put an additional pressure on inflation rates of emerging economies like India that were already struggling to rein in their spiraling inflation.

As a consequence of these inherent risks, in the recent week the world saw unusual volatility in the currencies of India, Brazil, and other emerging economies. This was indeed triggered by the fears of an early wind-up of the QE policies in developed nations like U.S. As the interest rates started rising the bond markets in the U.S became more attractive.

This caused western institutional investors to pull out of their investments in debt assets of emerging economies, on a sudden and massive scale. As a result, the currency exchange rates of these emerging economies came under huge pressure and the world witnessed one of the most rapid intraday declines in the Asian currencies, especially in India, whose INR touched a life time low of 58.98 against the USD. This has led the emerging economies, especially the BRICS nations, to criticize the controversial QE policies in the major western economies.

Apart from the effect on emerging nations the QE policy also had a considerable effect on the prices of bullion and other commodities like crude oil. Gold and crude oil prices fluctuated enormously due to the prospects of an early QE policy wind-up. History shows how the previous QE policies adopted by countries like Japan had adversely affected the Asian economies and had partly caused the Asian financial crisis in 1998.

The major western economies’ currencies form the global basket of reserve currency and hence play a major role in the fluctuations of the currencies of emerging economies. Therefore, it would be in the best interest of the global economy, if these major western economies pursued their QE stimulus packages with adequate caution and responsibility towards the Asian and other emerging economies of the world.

One has to wait and watch, whether the major western economies’ next round of QE policy, whose previous effects have already jeopardized the currencies of Asian and emerging economies, will further cast them into a deep financial crisis.