FYI | Nov 21 2008
By Chris Shaw
While it is clear the credit crisis of the past 12 months or so has precipitated the global economic growth slowdown, the question now becomes what can be done to turn things around? Investment research group State Street Global Markets suggests policymakers in the US are adopting a form of quantitative easing in their attempts to avoid a protracted slump in the economy.
Since the crisis began policymakers have been focussed on restoring the supply of credit to consumers and businesses, as the freezing of credit markets effectively stopped economy activity. But the group points out the US Federal Reserve also appears to be discouraging saving as it moves to expand the quality of its current account.
There is clear evidence of this focus on the current account, as State Street notes the Federal Reserve’s balance sheet has expanded from US$798 billion in September to US$2.2 trillion now. At the same time, reserve balances held by deposit taking institutions have risen from US$32 billion to US$594 billion in the same period.
It is these changes that suggest quantitative easing is now under way and the group points out the policy has a number of aims. The first is that with policy rates at or near zero (and official interest rates in the US are not that far away from this level), pumping additional funds into the financial system is designed to further ease monetary conditions.
This not only provides an additional level of support for the banking system, but when banks have excess liquidity they are encouraged to lend more money. As well, by reducing the risk premium on government bonds, there is less incentive for banks to hoard cash It also encourages consumers to spend or save by the purchase of riskier assets.
This policy is somewhat similar to that introduced in Japan in the early years of this decade as that country struggled to deal with the aftermath of the collapse of the bubble economy in around 1990. However, State Street notes it took almost five years for the policy to be considered a success in the Japanese economy.
The good news is State Street doesn’t expect it would take that long for benefits to flow through in the US, as there are significant differences between the two economies. Firstly, US policymakers are being far more proactive than their Japanese counterparts, who waited for more than a decade before introducing the measures.
As well, the US is far more advanced in terms of addressing the problems in their banking system, which again the Japanese didn’t do for a number of years. Deflation was an issue for much of the 1990s in Japan and it meant consumers put off purchases, but as the group points out, US Fed chairman Ben Bernanke is likely to do everything in his power to prevent any outbreak of deflation in the US economy.
Demographics are also in favour of the policy working more quickly in the US, as its population is far younger than that of Japan and evidence suggests older people consume less, a fact that worked against Japanese policymakers. The final point is a cultural one, as State Street notes Americans are simply more in love with shopping than their Japanese counterparts. Thsi means quantitative easing is essentially another attempt to find a catalyst to encourage them to do so for the good of the economy overall.
