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INTERNATIONAL FINANCE TERM PAPER 2015

Quantitat ive Eas ing in US an d its i!a"t # n Ind ia

Nae$ Pi%us& Ra"&andani

R#'' N#$ F(5)

M*M*S* II Finan"e +201,(1-.

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Table of Contents

Sr. No. Title Pg.No.

1. What is Quantitative Easing 3

2. Importane of Quantitative Easing 3

3. !"ths about Quantitative Easing #

#. $easons to a%opt Quantitative Easing &

&. The %o'nsi%es of Quantitative Easing &

(. E)amples of Quantitative Easing (

*. Quantitative Easing in the +S ,

-. Impat on +S eonom" 12

,. Impat on In%ian eonom" 12

1. /ibliograph" 13

2 Pi"ush $amhan%ani 0 &, 0 !!SII inane4 0 5/I!SQuantitative Easing in +S an% its impat on In%ia

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/& at is Qu an titative Easin g

The term 6Quantitative Easingbeame a popular 7argon in 2,. Central ban8s are

responsible for 8eeping inflation in he8. /efore the finanial risis of 2-,9 the"manage% that b" a%7usting the interest rate at 'hih ban8s borro' overnight. If firms 'ere

gro'ing nervous about the future an% saling ba8 on investment9 the entral ban8 'oul%

re%ue the rate. This 'oul% re%ue ban8s: fun%ing osts9 enourage them to ma8e more loans

an% 8eep the eonom" from falling into reession. ;n the other han%9 if re%it an% spen%ing

'ere gro'ing out of boun% an% inflation 'as rising9 entral ban8 'oul% re%ue the rates.

When the risis stru89 big entral ban8s li8e the e% an% the /an8 of Englan% initiall"

re%ue% the rates to boost the eonom". /ut9 even re%uing the rate as far as possible9 to

almost

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ost to businesses for finaning apital investments9 suh as ne' e>uipment9 %ereases. ;vertime9 ne' business investment shoul% bolster eonomi ativit"9 reate ne' 7obs9 an% re%uethe unemplo"ment rate.

Quantitative easing is suppose% to benefit the eonom" beause the ash that the Is

reeive from the entral ban8 for the assets an then be loane% to borro'ers. Deneonsumers an% businesses 'ill borro' an% spen% more as interest rates %rop. Through the

purhase of longterm government bon%s9 the entral ban8 %ereases "iel%s an%9onse>uentl"9 overall finanial osts. QE also impats the eonom" b" %evaluing the homeurren" hene ma8ing e)port goo%s more ompetitive. Therefore it is believe% that theinrease in government e)pen%iture 'ill lea% to inrease% onsumption9 'hih 'ill furtherinrease the %eman% for goo%s an% servies9 thus fostering 7ob reation an%9 ultimatel"9reating eonomi vitalit".

M%t& s a #u t Quan titative Easin g

QE is p r in t ing mon e " Politiians9 7ournalists an% mar8et partiipants often refer to QE asFprinting mone":. /ut9 it %oesn:t atuall" %o an"thing to inrease the amount of mone" in

irulation. When government bu"s bon%s from ban8s9 it merel" rises the prie of that

partiular t"pe of bon% an% lo'ers the interest rate. Go'er interest rates might enourage

onsumers to ta8e out loans9 but it 'on:t atuall" lea% to more mone" in the s"stem unless

ban8s reate mone" through ma8ing loans. n% ban8s 'on:t %o that unless the" i%entif"

profitable len%ing opportunities.

QE ' il l ev e ntual l " l ea % t o inflation In eonomis9 inflation is %efine% as 6an ongoing rise

in the general level of pries. Auring inflationar" perio%s9 a single %ollar bu"s less ever"

"ear. Sine the entral ban8 is not printing mone" an% not %iretl" inreasing the amount

of mone" in the s"stem9 it is not sto8ing inflation. This %oes not impl" that Central

/an8:s poli" an:t ever lea% to inflation. /ut the i%ea that interest rates are lo' right no'

%oesn:t ma8e a lot of sense given the large amount of sla8 in the eonom" as sho'n b"

high unemplo"ment an% stagnant 'age gro'th.

QE is re spons ible f or r e e nt s to 8 ma r 8 e t h i g hs Central ban8 bu"ing bon%s 'ill ause

bon% pries to go higher an% interest rates to be lo'er9 an% this 'ill enourage investors to

hoose sto8s over bon%s at the margin. /ut no amount of fe%eral bon% bu"ing is going to

ause a partiular sto8 to be a goo% bu" if an investor %oesn:t thin8 that the sto8 'ill

provi%e a return. QE ma" boost profits b" re%uing the interest rates firms have to pa" on

their %ebt9 but it is not going to reate profitable enterprises out of this solel".

C e ntr a l ban8 is fin a n in g the t rea su r " Central ban8 bu"s bon%s in the seon%ar"mar8et that have alrea%" been issue% b" the treasur". Central ban8 is not bu"ingtreasur" seurities beause there is a la8 of %eman% in the open mar8et9 but beause itis implementing its monetar" poli". The onl" time a entral ban8 'oul% be re>uire% to

purhase bon%s to meet a Treasur" fun%ing shortfall is if investors refuse% to purhasethem an% the Central ban8 ha% to step into the breah.


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Reas#n s t# ad#! t Qu antitative Easin g

+n%er e)tremel" a%verse irumstanes9 a Central /an8 an ut the nominal interestrate all the 'a" to ui%it" trap:. Ifinflation then falls9 the real interest rate rises9 s>ueeuirement is at a historiall" lo' level. Dene9 the urrent

level of e)ess reserves oul% reate a massive inrease in the mone" suppl" shoul% ban8s

signifiantl" inrease their len%ing or investing.

seon% reason is the onsi%erable %isagreement bet'een eonomists an% poli"ma8ers

about 'hether an% to 'hat e)tent mone" gro'th per se is inflationar". In the maro

eonomi mo%el ommonl" use% for the anal"ses of monetar" poli"9 inflation is

%etermine% b" inflation e)petations an% the gap bet'een atual an% potential output.

thir% reason for onern is that emplo"ment gro'th is unharateristiall" slo' %uring

this reover". Get us ta8e an e)ample of +S post finanial risis. t fifteen months past

the reession:s en%9 emplo"ment 'as onl" slightl" above its postreession trough.

iven that a%%itional >uantitative easing ma" have onl" mo%est effets on eonomi

gro'th9 emplo"ment or inflation an% the potential to signifiantl" e)aerbate the Central

/an8:s problems 'hen the time omes to restore the balane sheet to a more normal

onfiguration9 it is eas" to un%erstan% the onsi%erable %isagreement about the %esirabilit" of

suh a poli". Some poli" ma8ers believe that potential benefits of Quantitative easing are

lo'er than the potential osts.


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Ea ! 'es # Q u a n ti t a t ive Eas in g

EC / :s i) e % $ate t e n%e r 9 f ull a ll otm e nt pro g r a ms The 3month Euribor =

overnight in%e)e% s'ap ;IS4 sprea% 'i%ene% as finanial on%itions %eteriorate%. ;n

;tober 19

2-9 the sprea% hit an all time high of 1,- basis points9 'hih reflete% the sharp rise in

ounterpart" ris8. The EC/ respon%e% to these 'i%ening sprea%s on ;tober 1&9 2-9

'ith first measure of QE The EC/ announe% it 'oul% len% as muh as ban8s 'ante% at

a fi)e%rate ten%er provi%e% the ban8s ha% ollateral ? 'hile also e)pan%ing the list of

eligible ollateral. These fi)e%rate ten%er9 fullallotment $4 operations reverse% the

EC/:s onventional poli" of offering a fi)e% allotment of fun%s at rates %etermine% b"

the bi%%ing proess.

The EC/ implemente% the $ li>ui%it" provision through its usual len%ing

proe%ures. In normal times9 the EC/:s primar" poli" instrument is refinaning

operations9 %iret len%ing to ban8s against eligible ollateral at t'o maturities. !ain

refinaning operations !$;s4 have a perio% of t'o 'ee8s an% longerterm refinaning

operations GT$;s4 have a perio% of three months. In the usual !$;s an% GT$;s9 the

EC/ pre%etermines the amount of fun%ing available an% autions those fun%s b" prie.

+n%er the ne' poli"9 the EC/ fille% all !$; an% GT$; loan re>uests at the EC/:s

primar" poli" rate9 the main refinaning rate. rom ;tober 2- to !a" 2,9 the

EC/ ut this rate from #.2& perent to 1 perent.

/ini Smaghi 2,4 alls the $ li>ui%it" poli" 6en%ogenous re%it easing

beause ban8s: %eman% for li>ui%it" at the fi)e%rate ten%er %etermines li>ui%it".


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e % : s Q E1 Prog ra ms While the EC/ e)pan%e% ban8 len%ing operations9 the e%eral

$eserve pursue% outright asset purhases. ;n November 2&9 2-9 the e%eral $eserve

announe% plans to purhase @1 billion in governmentsponsore% enterprise SE4

%ebt an% @& billion in mortgageba8e% seurities !/S4 issue% b" those SEs Table

14.1& ;n !arh 1-9 2,9 the e% announe% a%%itional purhases of @1 billion inSE %ebt9 @*& billion in !/S9 an% @3 billion in longterm Treasur" seurities.

The e%:s November 2- an% !arh 2, asset purhase programsJommonl"

alle% 6QE1J'ere %esigne% to support the entire eonom" but the" naturall"

prioritiualit" private setor assets to 6inrease the availabilit"

of orporate re%it9 b" re%uing the illi>ui%it" of the un%erl"ing instruments. /eauseD! Treasur" issue% sol%4 shortterm gilts to finane the purhases9 ever" asset that the


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/;E purhase% 'as mathe% b" a sale of a shortterm gilt an% so the /;E:s liabilities

the monetar" base4 %i% not initiall" inrease. That is9 this 'as not initiall" QE. The /;E

later %esribe% its private asset purhases as 6an e)ample of the /an8 ating as mar8et

ma8er of last resort /;E9 2124. The /;E li8e'ise purhase% orporate bon%s through

a reverse autionK potential ounterparties bi% on the prie at 'hih the" 'oul% sell assets

to the /;E. The program 'as %esigne% so the /;E:s appeal as a ounterpart" 'oul%

%iminish as mar8et on%itions improve%.

In summar"9 from 2- through 2129 three entral ban8s the /;E9 /;59 an% EC/4

purhase% assets 'ith private re%it ris8 e)posure9 removing suh ris8 from the publi:s

balane sheet. Three entral ban8s the e%9 /;59 an% /;E4 attempte% to use asset purhases

to stimulate the eonom" through tra%itional interest rate hannels b" purhasing longterm

assets9 re%uing the amount of %uration hel% b" the publi an% thus lo'ering longterm real

interest rates. ll four entral ban8s use% asset purhases to improve the funtioning of

speifi mar8ets.


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Q u a n ti t a t ive Eas in g in t & e US

In 2-9 the e%eral ;pen !ar8et Committee ;!C4 lo'ere% the fe%eral fun%s rate

to uantities of agen" %ebt an% mortgage ba8e% seurities an% stoo% rea%"

to e)pan% its purhases. The e%eral $eserve Aeember 39 2- announement state% the

e%eral $eserve 6e)pets to begin operation in earl" 5anuar" announe% program to

purhase !/S an% that it has selete%.

The ;!C !arh 1-9 2, announement 6further inreasing the si

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The ;!C November #9 2, announement in%iate% 6@1*& billion of agen" %ebt

'oul% be purhase%9 far less than the previousl" announe% ma)imum of @2 billion9

an% reiterating the program 'oul% be omplete% b" the en% of the first >uarter of 21.

The Committee follo'e% through an% b" the en% of !arh9 the remaining purhases ha%

been omplete% an% QE1 ame to a lose.

Federal Reserve System Assets: January 2007 December 2014

QE2

The ;!C ugust 19 21 announement in 'hih the e%eral $eserve implemente% a

ne' poli" to 68eep onstant the e%eral $eserve:s hol%ings of seurities at their urrent

level b" reinvesting prinipal pa"ments from agen" %ebt an% agen" mortgageba8e%

seurities in longerterm Treasur" Seurities.

fter the initial e)pansion of the e%eral $eserve:s balane sheet %uring QE19 the e%eral

$eserve %i% not pursue a%%itional purhases or reinvestment of !/S an% agen" %ebt

'hih resulte% in a %erease in the si

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The ;!C November 39 21 announement mar8e% the offiial beginning of QE2. In

the announement9 the ;!C %elare% it inten%s to purhase a further @( billion of

longerterm Treasur" seurities b" the en% of the seon% >uarter of 2119 at a pae of

about @*& billion per month.

QE3

The ;!C September 139 212 statement mar8ing the offiial announement of QE3.

The ;!C state% it inten%e% to purhase 6a%%itional agen" mortgageba8e% seurities

at a pae of @# billion per month.#( In ontrast to QE1 an% QE29 no time table 'as

given for the en% of the program an% the total si

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I! a"t #n US e"#n # %

In the "ears follo'ing the reession an% finanial risis9 private setor foreasters

pushe% their e)pete% time for the tightening of monetar" poli" progressivel" further into

the future9 presumabl" in response to the e%eral reserve:s >uantitative easing an%

inreasingl" aggressive for'ar% gui%ane for the e%eral fun%s rates9 in the onte)t of a slo'eonomi reover" 'ith mo%erate inflation. lthough the e%eral reserve:s >uantitative

easing program li8el" helpe% to stabili

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http://www.forbes.com/sites/greatspeculations/2015/11/16/quantitative-easing-in-focus-the-u-s-experience/http://www.forbes.com/sites/greatspeculations/2015/11/16/quantitative-easing-in-focus-the-u-s-experience/http://www.forbes.com/sites/greatspeculations/2015/11/16/quantitative-easing-in-focus-the-u-s-experience/http://www.federalreserve.gov/econresdata/feds/2015/files/2015005pap.pdfhttps://research.stlouisfed.org/publications/es/10/ES1017.pdfhttp://www.federalreserve.gov/pubs/ifdp/2014/1109/ifdp1109.pdfhttp://www.federalreserve.gov/pubs/ifdp/2014/1109/ifdp1109.pdfhttp://www.dbfsindia.com/downloads/research/daily/fed180913.pdfhttp://esource.dbs.ie/bitstream/handle/10788/2155/msc_venkataramanan_s_2014.pdf?sequence=1http://esource.dbs.ie/bitstream/handle/10788/2155/msc_venkataramanan_s_2014.pdf?sequence=1http://esource.dbs.ie/bitstream/handle/10788/2155/msc_venkataramanan_s_2014.pdf?sequence=1http://www.economist.com/blogs/economist-explains/2015/03/economist-explains-5http://www.economist.com/blogs/economist-explains/2015/03/economist-explains-5http://www.economist.com/blogs/economist-explains/2015/03/economist-explains-5http://www.scmp.com/business/economy/article/1054708/quantitative-easing-what-it-why-its-importanthttp://www.scmp.com/business/economy/article/1054708/quantitative-easing-what-it-why-its-importanthttp://www.scmp.com/business/economy/article/1054708/quantitative-easing-what-it-why-its-importanthttp://www.scmp.com/business/economy/article/1054708/quantitative-easing-what-it-why-its-importanthttp://www.scmp.com/business/economy/article/1054708/quantitative-easing-what-it-why-its-importanthttp://business.time.com/2013/09/18/taper-tantrums-3-myths-about-quantitative-easing/http://financialservices.about.com/od/StrategiesandResearch/fl/3-Quantitative-Easing-Myths-for-Financial-Services.htmhttp://financialservices.about.com/od/StrategiesandResearch/fl/3-Quantitative-Easing-Myths-for-Financial-Services.htmhttp://financialservices.about.com/od/StrategiesandResearch/fl/3-Quantitative-Easing-Myths-for-Financial-Services.htmhttp://financialservices.about.com/od/StrategiesandResearch/fl/3-Quantitative-Easing-Myths-for-Financial-Services.htmhttps://research.stlouisfed.org/publications/es/10/ES1034.pdfhttp://www.federalreserve.gov/econresdata/feds/2015/files/2015005pap.pdfhttp://www.nber.org/papers/w17555.pdfhttp://www.elon.edu/docs/e-web/students/ipe/volumes/nellis%202013.pdfhttp://www.elon.edu/docs/e-web/students/ipe/volumes/nellis%202013.pdfhttp://www.elon.edu/docs/e-web/students/ipe/volumes/nellis%202013.pdfhttps://www.bostonfed.org/news/speeches/rosengren/2015/020515/020515figuresandcomments.pdfhttps://www.bostonfed.org/news/speeches/rosengren/2015/020515/020515figuresandcomments.pdfhttps://www.bostonfed.org/news/speeches/rosengren/2015/020515/020515figuresandcomments.pdfhttps://www.bostonfed.org/news/speeches/rosengren/2015/020515/020515figuresandcomments.pdfhttps://research.stlouisfed.org/publications/review/13/01/Fawley.pdfhttps://research.stlouisfed.org/publications/review/13/01/Fawley.pdfhttp://www.frbsf.org/economic-research/files/wp2013-26.pdfhttp://www.frbsf.org/economic-research/files/wp2013-26.pdfhttp://www.crisil.com/crisil-young-thought-leader-2012/dissertations/6-anusha-magavi.pdfhttp://www.crisil.com/crisil-young-thought-leader-2012/dissertations/6-anusha-magavi.pdfhttps://www.princeton.edu/ceps/workingpapers/204blinder.pdfhttp://www.forbes.com/sites/greatspeculations/2015/11/16/quantitative-easing-in-focus-the-u-s-experience/http://www.federalreserve.gov/econresdata/feds/2015/files/2015005pap.pdfhttps://research.stlouisfed.org/publications/es/10/ES1017.pdfhttp://www.federalreserve.gov/pubs/ifdp/2014/1109/ifdp1109.pdfhttp://www.dbfsindia.com/downloads/research/daily/fed180913.pdfhttp://esource.dbs.ie/bitstream/handle/10788/2155/msc_venkataramanan_s_2014.pdf?sequence=1http://esource.dbs.ie/bitstream/handle/10788/2155/msc_venkataramanan_s_2014.pdf?sequence=1http://www.economist.com/blogs/economist-explains/2015/03/economist-explains-5http://www.scmp.com/business/economy/article/1054708/quantitative-easing-what-it-why-its-importanthttp://www.scmp.com/business/economy/article/1054708/quantitative-easing-what-it-why-its-importanthttp://business.time.com/2013/09/18/taper-tantrums-3-myths-about-quantitative-easing/http://financialservices.about.com/od/StrategiesandResearch/fl/3-Quantitative-Easing-Myths-for-Financial-Services.htmhttp://financialservices.about.com/od/StrategiesandResearch/fl/3-Quantitative-Easing-Myths-for-Financial-Services.htmhttps://research.stlouisfed.org/publications/es/10/ES1034.pdfhttp://www.federalreserve.gov/econresdata/feds/2015/files/2015005pap.pdfhttp://www.nber.org/papers/w17555.pdfhttp://www.elon.edu/docs/e-web/students/ipe/volumes/nellis%202013.pdfhttps://www.bostonfed.org/news/speeches/rosengren/2015/020515/020515figuresandcomments.pdfhttps://www.bostonfed.org/news/speeches/rosengren/2015/020515/020515figuresandcomments.pdfhttps://research.stlouisfed.org/publications/review/13/01/Fawley.pdfhttp://www.frbsf.org/economic-research/files/wp2013-26.pdfhttp://www.crisil.com/crisil-young-thought-leader-2012/dissertations/6-anusha-magavi.pdfhttps://www.princeton.edu/ceps/workingpapers/204blinder.pdfhttp://www.forbes.com/sites/greatspeculations/2015/11/16/quantitative-easing-in-focus-the-u-s-experience/

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