Quantitative easing and its impacts on the us economy,

STATE BANK OF VIETNAM BANKING ACADEMY Foreign Language Faculty - - GRADUATION THESIS QUANTITATIVE EASING AND ITS IMPACTS ON THE US ECONOMY Lecturer : Pham Thi Hoang Anh (Ph.D) Student : Le ThiThanhHoa Class : K14-ATCB Student Code : 14A7510074 20th May 2015 Banking Academy Graduation Thesis ACKNOWLEGEMENTS First and foremost, I would like to express my heartfelt thanks toMrs Pham ThiHoang Anh, Ph.D for her enthusiastic guidance and precious advice I could hardly complete my graduation thesis on “Quantitative Easing and its impacts on the US economy” without her closely and dedicated supervision Secondly, I would like to show my appreciation to all the lecturers in Banking Academy, especially lecturers in Foreign Language Department, who provided me with useful background knowledge during the last four years Last but not least, I am grateful to my beloved parents for their blessings, my classmates for their help in finding data and statistics as well as their best wishes for the success of my graduation thesis Although I have made great effort to complete this thesis, it would certainly not be free from defect because of the time constraints and limited capacity of mine I hope that lectures and readers could sympathize and contribute to complete the thesis Sincerely Hanoi, June 2015 Le ThiThanhHoa K14ATCB Banking Academy Graduation Thesis STATEMENT OF ORIGINALITY I hereby would like to declare in lieu of oath that this thesis submission with the title ‘Quantitative Easing and its impacts on the US economy’ is my own work and to the best of my knowledge without any inadmissible help and without the use of any sources other than those listed in the list of reference Any contribution made to the research by other people is explicitly acknowledged in this thesis I would like to further declare that all that the intellectual content of this thesis is the product of my own work, except to the extent that assistance from others in the project’s design and conception or in style, presentation and linguistic expression is acknowledged Le ThiThanhHoa Le ThiThanhHoa K14ATCB Banking Academy Graduation Thesis ABSTRACT After the Great Depression of the 1930s, the American economy experienced robust growth, with periodic lesser recessions, for the rest of the 20th century However, in the end of the first decade of 21st century, the recurrence of Great Recession which threatened the total collapse of large financial institutions once again opened a long dark period for the US economy The bursting of the US housing bubble, which reached its peak in 2006, was considered o be the root cause of the Great Recession US housing bubble resulted in the plummet of securities tied to US real estate pricing, damaging the global financial system The financial crisis was triggered by a complex interplay of policies that providing easier access to loans for borrowers with the purpose of encouraging home ownership, over-valuating the bundled subprime mortgages mainly based on the theory that housing prices would continue to escalate Due to the financial crisis, global economic growth saw significant slowdowns The U.S Federal Reserve and central banks around the world took steps to mitigate and avoid the risks of a deflation spiral, in which lower wages and higher unemployment led to self-reinforcing decline in global consumption In US, a series of instruments was implemented by Fed; however, the leading economy was still obsessed with the bleakeconomic outlook In late 2008, Fed decided to carry out QE as the final measure with the aim of creating strong motivation for the economy to recover This thesis would deeply analyze QE and how it was implemented to rescue the US economy trapped in the recession Whether or not it left behind any risks for the US economy would also be included in this thesis Le ThiThanhHoa K14ATCB Banking Academy Graduation Thesis TABLE OF CONTENT ACKNOWLEGEMENTS STATEMENT OF ORIGINALITY ABSTRACT TABLE OF CONTENT LIST OF FIGURES AND TABLES 10 LIST OFABBREVIATION 12 CHAPTER 1: INTRODUCTION 1.1 Background Le ThiThanhHoa K14ATCB Banking Academy Graduation Thesis 1.2 Research Objectives 1.3 Methodology 1.4 Data source 1.5 Research question 1.6 Scope and Limitations 1.7 Thesis structure CHAPTER 2: LITERATURE REVIEW CHAPTER 3: THEORETICAL FRAMEWORK Le ThiThanhHoa K14ATCB Banking Academy Graduation Thesis 3.1 An overview of Quantitative Easing 3.1.1 Definition of Quantitative Easing 3.1.2 General impacts of Quantitative Easing on the economy 3.1.2.1 Effectiveness of Quantitative Easing 3.1.2.2 Risks of Quantitative Easing 3.2 Precedents CHAPTER 4: ANALYSIS AND RESULTS 13 4.1 Background of US economy in 2008 Le ThiThanhHoa K14ATCB Banking Academy Graduation Thesis 13 4.2 Timeline of Quantitative Easing in US and its impacts on the US economy 17 4.2.1 QE1 and its impacts on US economy 17 4.2.1.1 Timeline of QE1 17 4.2.1.2 Impacts of QE1 on the US economy 18 4.2.2 Timeline of QE2 and its impacts on the US economy 24 4.2.2.1 Timeline of QE2 24 4.2.2.2 Impacts of QE2 on the US economy 24 Le ThiThanhHoa K14ATCB Banking Academy Graduation Thesis 4.2.3 Operation Twist and its impacts on the US economy 29 4.2.3.1 Timeline of Operation Twist 29 4.2.3.2 Impacts of Operation Twist on the US economy 29 4.2.4 Timeline of QE3 and its impacts on the US economy 34 4.2.4.1 Timeline of QE3 34 4.2.4.2 Impacts of QE3 on the US economy 34 CHAPTER 5: CONCLUSION 40 REFERENCE 42 Le ThiThanhHoa K14ATCB Banking Academy Graduation Thesis APPENDICES 43 Le ThiThanhHoa K14ATCB Banking Academy Graduation Thesis US economy as housing bubble did However, it was irrefutable that QE3 brought about abundant benefits for US when it continued to create economic development stimulus Le ThiThanhHoa 39 K14ATCB Banking Academy Graduation Thesis CHAPTER 5: CONCLUSION The Great Recession not only opened a long dark period for the US economy With great effort to rescue the domestic economy which was trapped in recession, FED put their reliance on QE However, whether or not three doses of QE conducted by FED were effective enough was still under debate On Fed’s standpoint, although QE, in short-term, could be considered to be successful, it was not highly appreciated in long-term as it caused burden for the US economy.Indeed, by pouring a large volume of money into the economy, FED helped to raised fundamental economic indicators; for example, inflation rate, growth rate, S&P500, etc Nevertheless, its impacts were not stable and strong enough since most of these indicators, other than following a particular trend, saw a lot of fluctuations Additionally, the act of purchasing a large amount of securities left Fed with the asset side whose value was overestimated Consequently, FED would face with big difficulties in the time to come when its assets become to fall in value American people believed that QE, other than mitigating the financial difficulties of all US citizens, could only benefit a part of them Take the USD/EUR exchange rate as a prime example FED focused on reducing the value of USD with the hope of stimulating domestic production In another word, the depreciation of USD was to support the exporters since it helped them to gain profit However, simultaneously, it caused losses for the importers as they had to pay much more money for imported goods Also, according to economic analysts, QE was a selfish policy of US Economic analysts explained that, by releasing a huge amount of USD in circulation, US succeeded in allocating its burden to many other countries because USD is widely used all over the world Le ThiThanhHoa 40 K14ATCB Banking Academy Graduation Thesis However, it was irrefutable that QE witnessed an enormous merit in creating a relatively solid base for the development of US economy Specifically, thanks to QE, the securities market had opportunities to revive and experienced fast-paced develop QE also reached predetermined target when it succeeded in maintaining the inflation rate at acceptable level which was 2% The drop of the mortgage rate and long-term interest rate made huge contribution to the success of QE as well In summary, although there existing various opinions about QE, I personally think that it made a great progress for US economy It is undeniable that after the ending of QE, US economy gradually recovered and position of a leading economy still belongs to US Le ThiThanhHoa 41 K14ATCB Banking Academy Graduation Thesis REFERENCE [1] Hiroshi Ugai (2006), Bank of Japan Working Paper Series: “Effect of Quantitative Easing Policy: A survey of Empirical Analyses”, Bank of Japan, pp12-46 [2] Erica Fernandes, PGDM (International Business) and K.J Somaiya, Institute of Management Studies & Research (SIMSR), Mumbai (2012): “Quantitative easing: A blessing or a curse” [3] Tim Sablik (2012), Jargon Alert: “Operation Twist”, pp10 [4] Eric S Rosengren (2015), President & Chief Executive Officer Federal Reserve Bank of Boston: “Lessons from the U.S Experience with Quantitative Easing”, the Peterson Institute for International Economics and Moody’s Investors Service's 8th Joint Event on Sovereign Risk and Macroeconomics, pp 5-13 [5] Lance Vought (2011), Eastern Michigan University: “The effect of Quantitative Easing on long-term interest rates”, pp3-11 [6] Jens H E Christensen, Federal Reserve Bank of San Francisco and James M Gillan, University of California at Berkeley (2015): “Does Quantitative Easing affect Market Liquidity” [7] Arvind Krishnamurthy and Annette Vissing-jorgensen(2011), Northwestern University: “The Effects of Quantitative Easing on Interest Rate: Channels and Implications for Policy”, Brookings Papers on Economic Activity, pp2018-286 Le ThiThanhHoa 42 K14ATCB Banking Academy Graduation Thesis APPENDICES Appendix 30-year fixed-rate mortgage Source: US Bureau of Economic Analysis Le ThiThanhHoa 43 K14ATCB Banking Academy Graduation Thesis Appendix Table of Inflation Rates (%) by Month and Year (1999-2015) Source: US Bureau of Labor Statistics Le ThiThanhHoa 44 K14ATCB Banking Academy Graduation Thesis Appendix Quantitative Easing Is Ending Here’s What It Did, in Charts Neil Irwin (2014), New York Times The era of quantitative easing is over, for now, and in the United States, at least But the consequences of the Federal Reserve’s policy to pump trillions of dollars into the financial system in hopes of stimulating the economy will long be with us Fed policy makers met Wednesday and announced that October would conclude their third round of using dollars created out of thin air to buy vast sums of bonds — $1.7 trillion in just the third round of the program, known across the land (or at least the financial world) as QE3 The program has managed a rare trick of being perpetually maligned on Wall Street while driving asset prices up enough to make lots of people on Wall Street very wealthy But what we know about these three programs that eased monetary policy through unconventional means? The Fed faces a paradox Its goals are all related to the real economy It is charged by law with maintaining stable prices and maximum employment But its tools work through financial markets, principally buying and selling bonds So while the Fed’s impact on financial markets can be dramatic and easy to measure, its impact on the economy, which is the real goal, can be much squishier Still, here’s what we know about the successes (and failures) of more than five years of Q.E Quantitative Easing, in One Chart In three phases since late 2008, the Federal Reserve has bought trillions of dollars in bonds using newly created money to stimulate the economy QE3 is likely to end this month Total assets held by the Federal Reserve Le ThiThanhHoa 45 K14ATCB Banking Academy Graduation Thesis One chart shows its essence: the line showing the total size of the central bank’s balance sheet For years, it bounced along at a nearly constant level, until the 2008 financial crisis, when the Fed began using its power to create money, first to respond to the crisis, and when the intense phase of the crisis had passed, to try to boost an economy that kept underperforming And it’s not going anywhere anytime soon, by the way Janet Yellen, the Fed’s chairwoman, has indicated that the Fed will keep its large balance sheet in place for some time When it is time to tighten the money supply, it will start by raising shortterm interest rates, not by selling off some of the assets it has acquired Ben Bernanke, the former chairman of the Fed who engineered all three rounds of the program, drew a distinction between what he called “credit easing,” or pushing money into specific lending markets that had broken down, and “quantitative easing,” or increasing the money supply generally Le ThiThanhHoa 46 K14ATCB Banking Academy Graduation Thesis One simple way of looking at the distinction is by following the trend in what the Fed bought Traditionally, the Fed has held almost entirely United States government bonds, buying and selling them to adjust the money supply The idea is that they are a neutral asset, the bedrock from which other interest rates through the economy are set The Fed Has Bought Vast Sums of Mortgage-Backed Bonds In its first and third rounds of quantitative easing, the Fed bought not just the U.S government debt it has traditionally owned, but securities backed by Americans’ home mortgages Percentage of total Federal Reserve assets But during the first and third rounds of Q.E., the Fed has bought vast sums of mortgage-backed securities issued by government-sponsored firms like Fannie Mae and Freddie Mac, instead of just Treasuries Consumer and Business Borrowing Costs Have Fallen Amid the Fed’s quantitative easing programs, interest rates for both American homebuyers and large businesses have fallen Le ThiThanhHoa 47 K14ATCB Banking Academy Graduation Thesis The idea has been to try to channel money directly toward the troubled housing market; a flood of Fed money into mortgages has contributed to lowering the premium that Americans must pay to borrow money to buy a house If you are looking to buy a house and are surprised to learn you can get a mortgage at a rate not much higher than what the federal government pays to borrow money (that is, very low), it is reasonable to thank Ben Bernanke and Janet Yellen The practice remains controversial within the Fed, as it comes awfully close to picking winners and losers in the economy — in this case, favoring housing over other forms of investment What it has meant for markets When the Fed took trillions in government bonds and mortgage securities off the market, the investors who would have bought them had to find something else to buy Often the answer was corporate bonds With the increased demand, prices of those bonds went up and the interest rate that large companies must pay to borrow money on the bond market fell That made the environment more favorable for companies looking to expand or refinance old debts Le ThiThanhHoa 48 K14ATCB Banking Academy Graduation Thesis So both consumer and business borrowing costs fell sharply over the time the Fed’s money-creation was at full throttle But this rally, which has happened across a broad range of financial markets, is not without risks While a bubble is in the eye of the beholder, it is the case that many assets — almost all the major types of assets on earth, in fact — are at the high end of their historical valuations Consider one common measure of the stock market, valuations, as tracked by Yale University’s Robert Shiller It compares the valuation of the Standard & Poor’s 500 index with the inflation-adjusted earnings of companies over the preceding decade The idea is to filter out cyclical ups and downs and assess whether stocks are expensive or cheap relative to their long-term averages The Stock Market Has Returned to Pre-Bust Levels Stocks are trading at a level they previously only reached during the late 1990s stock market bubble and just before the financial crisis S&P 500-stock index, divided by average earnings over previous 10 years, inflation adjusted Le ThiThanhHoa 49 K14ATCB Banking Academy Graduation Thesis And the answer right now: They are expensive Not quite as richly valued as during the immediate run-up to the financial crisis and nowhere near as expensive as during the late 1990s stock market bubble but well on the high end of normal In other words, there is a risk that, aided by Q.E., financial markets have come back a bit too far, too fast, especially when compared with fundamentals like the amount of money companies are making What about inflation? One of the most urgent reasons for the program was the fear of deflation — that, as happened in the 1930s, once prices started falling, it could become a dangerous vicious cycle that would leave millions unemployed In early 2009, prices, especially for commodities, were in free fall This much can be said for Q.E.: It helped arrest that vicious cycle By late 2009, both the actual rate of inflation and investors’ expectations for future inflation were rising back toward the percent the Fed aims for The second round, announced in late 2010, helped guide them up further Inflation Remains Below the Fed’s Target Both inflation and inflation expectations remain below the percent annual rate the Fed aims for, despite three rounds of quantitative easing aimed at boosting inflation Le ThiThanhHoa 50 K14ATCB Banking Academy Graduation Thesis But even with the trillions of dollars pumped into the economy, the Fed has been perpetually unable to get inflation up to the percent level it aims for, except for the occasional brief period There is good news in that predictions by many Fed critics that Q.E would unleash vicious hyperinflation have come nowhere close to materializing But neither has it been enough for the Fed to reach its self-imposed goal In an economy trying to get out from under an overhang of debt, where excessive unemployment is the leading problem, too-low inflation can be deeply problematic andhold back growth Q.E has not been powerful enough to generate as much inflation as the Fed says it wants Where’s the growth? The good news is that the economy has been growing remarkably steadily since the middle of 2009 There were several moments when pundits warned that a dip back into recession was looming, but none materialized Fed policy is quite possibly a reason for that; every time a risk of recession seemed to pick up, Mr Bernanke & Co cooked up another round of Q.E that helped avert it Growth Has Been Too Weak to Return to the Pre-Crisis Trend Le ThiThanhHoa 51 K14ATCB Banking Academy Graduation Thesis Compared to “potential G.D.P.” — the level of output the economy would have at full employment and with factories operating at full capacity — the economy is still coming up short Inflation-adjusted gross domestic product, in billions of 2009 dollars Still, the pace of growth has been perpetually disappointing for anyone expecting or betting on a return to the pre-crisis trend Compared with the Congressional Budget Office’s estimate of “potential G.D.P.” — the level of output the economy would have if we were at full employment and our factories were cranking at full throttle — we’re still hundreds of billions of dollars short The Q.E.-driven recovery has been solid and consistent — but has not been able to push the economy toward a sharp rebound Le ThiThanhHoa 52 K14ATCB Banking Academy Graduation Thesis The job market tells a similar tale The third round of Q.E., launched in September 2012, was explicitly targeted at the job market, and was accompanied by an openended promise to continue until there was “substantial progress” toward improving the jobs situation So what has happened? Job Growth Has Been Steady but Not Extraordinary Private nonfarm employment, year-over-year change There really has been improvement in the rate of job creation After bouncing along at adding around two million private sector jobs a year in the early years of the recovery, the economy is now accelerating toward the 2.5 million range Some further acceleration would be welcomed by the jobless, but it seems that the Q.E.-driven recovery is now creating at least somewhat faster job growth The impact on jobs is a metaphor for the impact of Q.E more broadly It helped the economy recover But it wasn’t fast and it didn’t solve every problem Le ThiThanhHoa 53 K14ATCB