0:15
Let's tackle a different question then, related to monetary policy.
What happens if interest rates can't be low enough?
We've looked at what happens when they're too low, but
let's look at situations where interest rates can't go low enough.
So, here I've got a slide [COUGH] showing what's happened with the crisis.
And, these are the interest rates that are set, that are targeted
by the ECB, and the interest rate's targeted by the FED, okay?
So, you can see what's happened to those interest rates since the crisis broke.
We know the financial crisis, so you know, it was
it kind of started snowballing, the first event is in 2007.
2008 is when things really go very wrong.
So, you can see the Fed which is the
red line began to cut interest rates very, very quickly.
Alright.
And, it went down, all the way down to 0.25.
And it was there by 2009.
And then it stayed there.
Well, there's a clear reason why [LAUGH] it
stayed there, because you can't go below zero.
You can take your interest rates to zero,
but you can't have them be negative, right?
So the Fed took interest rates down as far as it could
at the moment of the crisis, but it couldn't go any further.
Now, we can see the ECB.
It came down slower with interest rates.
It got a little concerned about inflation there at the end of 2011,
brought them up, but now it also is almost all the way down.
Okay?
And, the crisis continues in Europe.
So, what do you do if you can't take interest rates
down any further, and you continue to be in a recessionary gap?
Let's look at another example.
This next slide shows Japan.
And here we can see, in Japan, now their crisis was in, started in the 90s.
They had a domestic banking crisis, that
was followed by the southeast Asian financial crisis.
Then, they sort of started to recover.
And then, the global financial crisis came.
So, you can see, here we've got some different interest rates.
So, we can compare them here.
But, you can see that their rates went
down to zero very quickly and stayed there.
Looking at the, the nominal call rate or the nominal discount
rate, you can see they went all the way down to zero.
Now, the real rates, the ones that go
negative, are subtracting inflation from those nominal rates.
But, normally, a central bank would not set a negative interest rate.
So, you can see, they went down to zero.
They came up just a little bit in the period the
early 2000s, when things were looking a little better for Japan.
They went down again and stayed at zero after that.
4:24
Or, what if, as we just observed, it's increasing
the monetary, the money supplies, it knows it should.
Interest rates have gone down, but they've gone as far as they can go.
And, we're still not seeing more investment
and therefore more aggregate demand in GDP.
We talked in an earlier session about
how sometimes this transmission mechanism breaks down.
And you can't get your money supply policy over
here into the real economy, more aggregate demand, more GDP.
Well, one of the things that central banks have started to
do, and this was started by Japan in their long crisis, was
to say, okay maybe the reason that this money is not
getting over there to the real economy is the financial crisis itself.
Banks are afraid, they're lacking liquidity, they look at
their balance sheets, they don't like the way they look.
And so, whenever the central bank provides liquidity to them through open
market operations, they take the money and they just hold onto it.
They keep it in their reserves, because they're worried about the future.
5:27
So, what central banks, beginning with the Bank of Japan,
said was, alright, if they need money to feel comfortable.
In order for the transmission mechanism to work, lend the
money, somebody spends it, we go to GDP, let's just
create a lot of money until banks finally have enough
reserves, enough cash, that they feel comfortable beginning to lend again.
So, that is what quantitative easing is.
It's where the central bank carries out very aggressive open market operations.
Selling many, or excuse me, buying many more bonds than
usual, and paying for them with much more cash than usual.
So, that the cash gets into the commercial banks, and they begin
to have enough liquidity that they can eventually start to lend money.
Well, this slide here shows what quantitative
easing has looked like in different countries.
And, we can see, actually the slide starts
after Japan was winding down its quantitative easing.
So, you can't really see the Japan effect, except that you
can see the curve for Japan, the red curve, is very high.
These curves measure, it says central bank assets, as a percent of GDP.
That means the central bank, how much does it hold
on its balance sheet of bonds, and other things, right?
But, mainly it's the bonds.
If the central bank is buying a lot of
bonds from the banking system and paying for them
with lots of cash to try to give liquidity,
then you will see the balance sheet growing, alright?
And, so you can see the Japanese balance sheet, you
can see central bank assets were 30% of Japanese GDP.
That's higher than any other country.
And, then you can see, they kind of wound down their quantitative easing.
And so, the Japanese curve is less interesting right now.
But you can see down at the bottom, you can
see the United States, and you can see the U.K., alright?
Both of them down there at about 7% of GDP.
That would be how much all the reserves of the
central bank were, bonds and the other things that they hold.
Now, you can see in 2008, suddenly that
number jumps dramatically for both of those countries.
In the U.S., it goes up to about 15% of GDP.
In the U.K., it goes up above 20% of GDP.
What's going on is both of these countries are doing quantitative easing.
They're buying lots and lots of bonds from commercial banks.
Giving cash for them, trying to get this transmission mechanism to work,
and that additional cash to work its way through into the real economy.
And, at the same time, you can see their
balance sheet growing with these additional bonds that they've bought.
And, you can see that both of them have stayed up at there, those high levels.
There hasn't been any winding down of
quantitative easing, as there was in Japan.
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Now, this chart ends in 2012, but one of the things you see in
the papers all the time, and I hope this will help you to understand.
Is news about whether the Fed is going to taper.
The term they use is taper its quantitative easing program.
Currently, the Fed is buying $85 billion
in bonds every month from commercial banks.
That's a lot of bonds.
That's a very big number.
And, we know that in open market
operations, you buy bonds from commercial banks.
You put cash into the economy if you want
to shift the money supply out to the right.
But, $85 billion is much more then the Fed
has ever bought from banks on a regular basis before.
So, the Fed has said it's going to continue doing this until
the unemployment rate is at a reasonable level in the United States.
Maybe 6.5%.
And the new Fed chairman says she will continue with this program.
But, markets are always watching for some
sign that the Fed will taper quantitative easing.
Meaning it's op, it's purchases, which
currently are $85 billion, will decline, right?
When that happens a lot of things could happen in financial markets, right?
There could be an effect on stock markets.
There've been a lot of discussions about what this actually does.
What's clear is that quantitative easing has been a great benefit to governments.
Because, again, if you think about our primary and
secondary markets that we talked about some time ago.
When the Fed is buying huge amounts of bonds in secondary markets
through commercial banks, actually, what's happening
is that the interest rate is dropping.
And so, when that low interest rate reaches the government in
a new option, it pays very little to finance its borrowing.
So, this is great for governments.
It saved them lots and lots of money.
It's maybe not so great for financial institutions,
for pension funds, specifically, or insurance funds, which
put money in bonds to get a return, and they're not getting much of a return.
It's a mixed bag for households because households save some money.
They're getting not very good returns on their savings.
They also borrow some money.
They're borrowing at low rates.
So, it's been a kind of a mixed bag for households.
It's been negative for foreigners because U.S. bonds
are attracting so much money and paying so
very little returns that foreigners that hold bonds
are, are not benefiting very much from those investments.
So, quantitative easing is one of the big topics of our day, and
what I want you under, to understand here is why it was done.
It was done because the transmission mechanism had broken down.
Interest rates could no longer go any lower.
And, monetary authorities are trying to find a way to exercise what tools they
have and influence the real economy and bring us out of our recessionary gap.
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[BLANK_AUDIO]
Gayle AllardProfessor
