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Thought Leadership

Changing Directions

Is quantitative easing leading us over a cliff edge?

Published

29th April 2020

Author

Gregory Perdon

Category

The global financial crisis of 2008 threw up an almost unprecedented challenge for central banks. With the world’s financial system at risk of collapse, a systematic set of measures were put in place by the central banks of the UK, Japan, European Union and the USA: quantitative easing.

In this report, we look at the implications of the widespread adoption of quantitative easing, how it’s affected the global economy and whether, in the long term, it could lead us off the cliff edge and into another financial crisis.

Quote -

When clients ask me what keeps me motivated through the ups and downs of the market, my answer is simple: a genuine curiosity to understand the biggest questions facing investors.

Today, the most significant questions revolve around the world of monetary policy, following the $15trn balance sheet expansion of the four major central banks since 2008.

But what impact has quantitative easing had on financial stability and prosperity? What do people need to know about what comes next? Whether you’re looking to buy your first house, or the CEO of a multinational organisation making complex financial decisions, these considerations affect everyone.

– Gregory Perdon, Co-Chief Investment Officer, Arbuthnot Latham
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What is Quantitative Easing?

It is a long-scale asset purchase programme. Put simply, central banks create money and buy things like bonds or gilts from investors or pension funds. They are essentially taking ownership of debt with money they have created.

The intended effect of buying these bonds is to reduce interest rates, which in turn puts more money in people’s pockets, stimulating the economy. That’s the theory…

Test your knowledge


1. QE was initially used to stimulate aggressive growth

or  

Incorrect

Our view is that is wasn’t that far-reaching. It was all about avoiding a 1929-style depression. The interconnectedness of the global economy meant that if one institution went down, so would the global financial system, like a house of cards. The message from the head of the Federal Reserve, Ben Bernanke was clear – the US government would never accept a financial collapse. This wasn’t stimulating growth; this was about ‘backstopping’ the financial system.

Correct

Our view is that is wasn’t that far-reaching. It was all about avoiding a 1929-style depression. The interconnectedness of the global economy meant that if one institution went down, so would the global financial system, like a house of cards. The message from the head of the Federal Reserve, Ben Bernanke was clear – the US government would never accept a financial collapse. This wasn’t stimulating growth; this was about ‘backstopping’ the financial system.

2. QE injected $4trn into the US economy

or  

Incorrect

The monetary base increased but the number of dollar bills floating in circulation (the monetary supply) did not. This monetary base gave financial institutions firmer grounding, and the buying of bonds drove down interest rates, but the banks didn’t loan more money. Owing to the perceived weak supply of attractive lending opportunities from borrowers, a cautious appetite to lend by banks, and increased capital requirements imposed by regulators (especially in Europe), a disincentive to lend was created. Although money was injected into the economy, it didn’t have a direct impact on the amount of money consumers could spend.

Correct

The monetary base increased but the number of dollar bills floating in circulation (the monetary supply) did not. This monetary base gave financial institutions firmer grounding, and the buying of bonds drove down interest rates, but the banks didn’t loan more money. Owing to the perceived weak supply of attractive lending opportunities from borrowers, a cautious appetite to lend by banks, and increased capital requirements imposed by regulators (especially in Europe), a disincentive to lend was created. Although money was injected into the economy, it didn’t have a direct impact on the amount of money consumers could spend.

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Author -

Gregory Perdon

Gregory Perdon

Co-Chief Investment Officer, Arbuthnot Latham

gregoryperdon@arbuthnot.co.uk

+44 (0)20 7012 2522