Quantitative Easing (Part 2): How it would NOT work11 October, 2010, 9:00. Posted by Zarathustra
Tags: Japan, Quantitative Easing
In the previous part, we discussed how quantitative easing should work. The problem was, Japan did that, and it did not really work in a sense that they did not prop up inflation for long enough time, and Japan is now back into deflation. Why did it fail?
Japan started their quantitative easing operation in 2001, a decade after their real estate bubble burst. They pushed the interest rate to zero, and went on to purchase assets. They buy securities and target their desired level of reserve in commercial banks to be higher than the reserve requirement, pushing down interest rates, at the same time to commit themselves to hold the interest rate low unless inflation stabilised at 0% or positive territory. In effect, the operation shift their policy objective from interest rate to reserve balance of the banks.
When monetary policy has moved to an unconventional territory, certainly no one would know what was going to happen. Today, perhaps many people would agree that quantitative easing by Bank of Japan has largely failed. To judge whether the operation was a success, we will look at some numbers and a few papers.
Some initial assessment of quantitative easing did not yield very good outcome. A paper by Mark Spiegel of Federal Reserve Bank of San Francisco suggested that while the operation produce good increase in M1, the response to the operation measured in broader money supply M2 and CDs did not respond well. Later in 2006 as that round of quantitative easing ended, Mark Spiegel thought the results were mixed. There are some effect found in government bond yields, the effect seemed to be not as much as would be desired.
But as far as the inflation is concerned, the Bank of Japan did not succeed. In one of our previous articles, we plotted Japan’s inflation and currency in a chart when we briefly touched on purchasing power parity. The chart shows that the inflation only increased above zero briefly in 2004 and 2006. For both times, inflation only stayed in positive territory briefly. Inflation only shot up in 2007-2008 when oil and commodities prices rose to record in their final run in the bull market, then inflation plunged to negative after the financial crisis and has never been back to positive territory.
Why did it fail? Why deflation seems so much harder to treat compared to inflation? In the next part, we will offer some economists’ views as well as our views on why even quantitative easing did not prop up inflation.