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Monday, March 30, 2009

What Is Quantitative Easing?

Put simply, it is the injection of liquidity into the financial system by central banks to jump start growth. While quantitative easing alludes to printing money, central banks have other means to do it, such as by buying assets like government bonds from the banks.

This way, the reserves of banks are raised which enables them to continue their lending activities.

With quantitative easing becoming more widely used to ease global credit crunch, the worry is that if continued for too long, it could hurt the currency and cause a bubble build in the assets that the implementing central bank is buying from the financial institutions.

Inflation can also be a by-product although in the current crisis, the threat of inflation has waned as prices have come down rapidly in the face of weakening demand.

The good news for us is that it is unlikely that there is a need for Malaysia to resort to quantitative easing as a policy option to mitigate the current economic downturn.

It is lucky in this regard because with the OPR at 2.5%, there is still room for the central bank to manoeuvre insofar as monetary policy is concerned. Additionally, the banking system is till flush with liquidity and the country’s fundamentals still strong.

Thus, of greater importance at this point in time is that monetary easing must be accompanied by fiscal measures that should be implemented as quickly as possible amid the deteriorating economic environment.

The US & Japan Entered The Territory Of Quantitative Easing …

The US .....

The Federal Reserve vowed to pump an additional US$1 trillion into the US economy in an aggressive bid to battle a deep recession, partly by buying government bonds for the first time since the 1960s.

The central bank said it would buy up to US$300 billion in longer-term Treasuries to bring down borrowing costs, harkening back to a program called "Operation Twist" that ran from 1961 to 1965.

In addition to purchasing Treasury debt, the Fed would expand an existing program to buy debt and securities issued by mortgage finance agencies by US$850 billion to US$1.45 trillion, an effort to lower mortgage rates.

Critics said that buying longer-term government debt was not the most efficient way to ease credit market strains.

The price of U.S. government bonds surged after the announcement, with yields taking their biggest one-day tumble since 1987. Stock prices also shot higher, while the dollar plunged. It's an attempt to keep rates low, particularly on the mortgage side, which is seen as critical to a big revival of the housing market.

The Fed would begin buying the Treasury debt late March 2009 and planned to focus on securities with maturities ranging from two years to ten years. It would make purchases about two to three times a week.

In addition to ramping up its efforts to pump money into the recession-struck economy, the Fed unanimously decided to hold its target for overnight interest rates in a zero to 0.25 percent range -- the level reached in December 2008.

The Fed said rates would stay low for "an extended period," a more explicit vow to stay on hold with rates for a prolonged time than it had offered in recent months.

JAPAN ......

The BOJ has effectively entered the territory of quantitative easing, and it may eventually shift its policy target towards that and cut interest rates to zero if it tries to further ease financial conditions to cope with worsening of the economy.

The BOJ would buy 12 trillion yen of the JGBs with maturities of one to 10 years, more than half the total of the 21.6 trillion allocated for purchases each year. The BOJ has has no intention of monetising government debt and it is not aiming directly at pushing down bond yields. JGB buying is just one of its many market operation tools to provide funds to money markets

Falls in Tokyo share prices have put a strain on banks’ capital adequacy ratios. The BoJ was concerned that banks’ declining capital ratios, if left unchecked, could lead to a fall in lending to businesses and deal a further blow to Japan’s recession-hit economy.

In a nutshell ......

In economics, quantitative easing is a monetary policy tool that allows central banks to boost money supply in the financial system by buying up assets such as government bonds and mortgage backed assets.

In plain speak, it means central banks are using the printing press to create new money to buy up these assets!!!

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