What quantitative easing means for the consumer sector?
What quantitative easing means for the consumer sector?
Publication by Stefan Mattsson
2048 Words | 12 min
Quantitative easing (QE) has been referred to by the Financial Times as the great monetary experiment of our age. During the financial crisis 2008-2009 central banks applied quantitative easing as a way to save the financial system. After the financial crisis QE policies continued to be used in order to further stimulate the economy involving massive monetary injections. Inflation in the developed world has however not risen as a consequence while unemployment rates continue to be low. It all seems to go against economic wisdom.
This paper aims at explaining more about QE and its potential consequences for the consumer sector. It urges the need to carefully follow and evaluate the macroeconomic environment and to be prepared.
In the footsteps of quantitative easing and its implications for the consumer sector
Background
Quantitative easing (QE) is a monetary policy applied by a central bank for injecting liquidity (money) in an economy. An increase in liquidity can for example be desired when the central bank wants to drive up inflation, lower interest rates or stimulate the economy. A central bank normally influences liquidity by lending money to the commercial banks under certain terms. However when interest rates already are low and the commercial banks then less keen on taking on more liquidity, the central bank can use QE to further increase liquidity. QE has in the past also been applied in times of crisis when central banks have reduced the strains on the financial system by taking over debt from the commercial banks.
Under a QE policy the central bank typically increases the size of its balance sheet by issuing credit to the commercial banks (creates money) in return for debt instruments such as government bonds or similar financial instruments. The central bank thus replaces debt with money and thereby provides the commercial banks with more liquidity. The banks can in their turn lend this money to households and companies thus increasing the supply of money in the economy. As a consequence, QE should drive up inflation, push down interest rates and stimulate the demand of goods and services and so on.
A central bank is normally independent of its government and has only monetary tasks. It is the government who decides on so called fiscal policies such as government spending, taxes and so forth. It seems as if central banks during the last years have been pulling a bigger weight than the governments in trying to influence the economy. The ECB has for example called for more action from its member governments in order to ward off weak economic growth and low inflation. An interesting question in this context is how central banks and governments are coordinated but this is not the topic here.
QE is a rather new policy form but has already been applied by some of the largest economies in the world. Following the financial crisis in 2008 QE policies became widely popular and have continued to be applied after the crisis. Between 2009 and 2019 the combined balance sheet of the central banks in the US, Euro area (ECB) and Bank of England grew with as much as USD 10 trillion. Although these large monetary values must be seen in relation to the size of the involved economies it is clear that enormous values have been injected via QE. The magnitude of new liquidity injected through QE has recently been tapered down but QE policies continue to be used although for slightly different reasons than saving banking systems.
An example of a QE policy applied after the financial crisis is from Sweden. The Swedish central bank started a quantitative easing program in 2015 with a government bond purchase program worth several billion USD. The bank also offered negative lending rates to the commercial banks in order to further stimulate borrowings by the banks. The Swedish central bank is still struggling to reach the desired annual inflation rate of 2% whereas the SEK has plummeted versus other currencies. Although when ECB started their massive QE programs the Swedish central bank claim that it needed to act. The SEK is a small currency within the EU and was threatened to strengthening when the supply of EUR increased. One can thus only assume that the weak SEK is a byproduct of the central bank’s actions although it has boosted Swedish exports by keeping the SEK weak.
It is perhaps no coincidence that QE has been referred to by the Financial Times as the great monetary experiment of our age.
What are the effects from QE?
The views on QE are ambiguous especially when comparing QE policies applied during the 2008 financial crisis with the QE policies applied afterwards. Many observers agree that QE policies used during the financial crisis probably helped to save the global financial system. QE policies applied after the crisis had different purposes and their effect are not so clear. Long term effects from QE whatever the reason are also less clear.
The financial crisis in 2008 was the deepest financial crisis since World War 2. The US stock market lost about USD 10 trillion in a very short time. When the investment bank Lehman Brothers went bankrupt in September 2008 and other big investment banks were threatened something had to be done. The Fed (the US central bank) initially bought almost one trillion (USD) worth of debt and so called mortgage backed securities from the banks in order to take these securities off the banks’ balance sheets. Other interventions were also made to support Bank of America, Citibank, the insurer AIG and the huge US mortgage institutions Fannie Mae and Freddie Mac and so on. These QE programs applied by central banks then were aimed at taking over so called toxic debt such as mortgage backed securities, not to drive up inflation etc.
IMF concludes that QE programs carried out during the financial crisis has had positive effects on the economy. The Bank of England is also positive to QE and believes it played a significant role in supporting the UK economy. One might add that these institutions are owners of QE policies and are speaking positively about QE. Former Governor of the Bank of England, Sir Mervyn King, has expressed that the banking sector is just too big to fail. This might be a fair explanation for QE applied in a time of crisis.
A potential risk of QE is that if it fails to stimulate economic growth while the liquidity injected together with for example low interest rates can create high inflation. This situation is known as stagflation and can have severe negative consequences on the economy.
QE injects liquidity which is likely to push up asset prices with the risk for financial bubbles. While some economists argue that there are currently relatively few indications of stock market bubbles there are still signs of a correlation between QE and stock prices. Stock prices have since the start of massive QE programs reached record levels and when for example the US central bank (Fed) ended their QE programs QE1 and QE2 the S&P 500 index sank with about 15 and 20% respectively. But when new QE programs later were announced stock indices climbed up again. Hence there is empirical support for the hypothesis for a correlation and causation between QE programs and the value of the stock market.
In Japan, the central bank has spent decades on various monetary policies such as QE in trying to spark life in a stagnant Japanese economy. As a result asset prices have increased and interest rates have been kept artificially low. Furthermore Japan is one of the most indebted countries in the world according to hedge fund manager Ray Dalio.
Before the financial crisis QE policies were relatively untried and little data exists for evaluating the long term effects of QE. Perhaps the Japanese experience can help to understand long term effects to some extent but even here it is difficult to find clear and general answers.
It seems that much of the money injected from QE has gone into the financial markets. This is in one way understandable since low interest rates have given few alternatives for investments to go to and commercial banks are supposed to generate profits. In the search for yield the stock market has been one of few alternatives available in the search for yield hence pushing up stock prices. QE policies carried out by the central banks carry no restrictions for the commercial banks on how the money received should be used. The banks could sit on the money or invest in stocks rather than trying to lend it to households.
Whatever reasons behind the commercial banks’ strategies as an outcome of QE it does not seems as if private consumption and thereby consumer markets have been stimulated. QE is far away from Milton Friedman’s idea about helicopter money handed out to the households in order to stimulate demand in the economy.
There are reasons for keeping an eye on the macro situation not only due to QE. In late 2018 the yield curve for US government bonds inverted. The spread of interest rates seen over different time horizons inverted such that yield on long term bonds fell below short term bonds. This phenomenon seems to have proceeded previous economic recessions. The US investment bank JP Morgan has released a report saying that it is possible that QE has reduced the predictive power of the inverted yield curve and therefore the inversion of the yield curve is a less valid indication of any oncoming economic downturn. This is of course only a view held by JP Morgan and not an exhaustive proof.
Consequences for the consumer sector.
In terms of consumer spending there is no evidence for that QE has caused any significant increases. One could of course argue that consumers have benefited from QE due to that the financial system did not crash following the 2008 financial crisis etc.
However one might suspect that the massive amounts of liquidity injected over several years of QE, which possibly achieved financial stability in a time of crisis and kept interests artificially low etc, can also have created future instabilities in the world economy. Some believe that QE has already changed the distribution of wealth among households benefitting the already rich. The European Central Bank (ECB) has issued a report saying that QE has not caused increased income or wealth differences partly due to that the poorer households have been compensated through a healthy job market. One just has to evaluate all information carefully and its potential consequences conditional on the situation.
Irrespectively of the underlying reasons several years of massive QE programs has significantly increased the supply of money. It has supported low interest rates, no significant additional economic growth except that economies are up and running, low inflation rates while stock markets seem to have benefited significantly. Have the risks for a coming stagflation increased?
On the other side lower interest rates imply lower borrowing costs and greater incentive to expand a business or perhaps to invest in a transformation for future demands. Well run corporations monitor interest rates and their capital structure carefully and have hopefully already utilized any opportunities due to lower interest rates and changes in underlying risks etc.
Lower interest rates also mean lower borrowing costs and greater incentive to expand a business and to move consumption earlier in time. Hence it is not worth delaying investments or consumption. Well run corporations monitor interest rates and their capital structure carefully and have probably already utilized any opportunities due to lower interest rates.
Have already wealthy households become even wealthier under quantitative easing? QE has most likely driven up asset prices such as stock prices and possibly also property values for more wealthy households. To which extent QE has caused a different consumer landscape needs to be evaluated per business with its unique customer groups. Remember that under a relatively stable average consumption levels there can still be movements between rich and poorer households which might be of interest for a retailer, financial service companies etc.
The general recommendation in this context following QE and its consequences for the consumer sector is to be aware of the nature of QE, what it has created and to evaluate the economy in more detail than ever as we go forward. We need to be aware of the risk of stagflation and to be prepared for any changes by carefully evaluating the economic situation.
Stefan Mattsson
Consultant | Investor
________
Stefan has a background in both academia and business.
More Publications
