Quantitative Easing (QE) is another form of expansionary monetary policy in which the Central Bank of a country purchases a large number of financial assets, such as bonds, from commercial banks and other financial institutions. The purchase of these assets in large amounts increases the excess reserves held by the financial institutions, facilitates lending, increases the money supply, drives up the price of bonds, lowers the yield, and lowers interest rates. A government will usually opt for quantitative easing when the conventional monetary stimulus is not very effective.
In dealing with the funding for the economic and social ravages of the coronavirus pandemic, most government are resorting to quantitative easing through either creating money and/or printing fresh notes to fund their coronavirus budgets. Notwithstanding, quantitative easing has been nicknamed “printing of money” by some members of the public.
The author of this paper wishes to explore the efficacy of using quantitative easing with or without printing new bank notes to fund government spending during this pandemic era.
CENTRAL BANKS AND QUANTITATIVE EASING UNDER COVID-19
In response to the massive economic contraction stemming from the coronavirus (COVID-19) pandemic, some central banks including those of the United States, European Union, Japan and other major economies are engaging in “quantitative easing” (QE) programs on an unprecedented scale. These programs involve large-scale asset purchases, namely central banks buying financial instruments such as government and corporate bonds. The goal is to inject liquidity into financial markets and stimulate economic activity.
Below shows a summary of some stimulus packages by the Central Banks of governments using quantitative easing.
- USA – as of April 21, 2020 the Federal Reserve embarked on significant quantitative easing and was buying about $41 billion in assets daily, these include corporate bonds of specific companies. By end of the year, the Federal Reserve is projected to purchase about $3.5 trillion (about 17.1% of GDP) in government securities with newly created dollars according to the Oxford Economics Journal.
- G7 Countries – central banks in the G7 countries have purchased about $1.4 trillion in assets as at April 21, 2020.
- United Kingdom (UK) – The Bank of England’s (BoE) stimulus package to prevent the country from going into a recession included a quantitative easing plan to purchase £10 billion worth of corporate debt from a pool of £150 billion (about 5.3% of GDP) in order to drive down borrowing costs.
- European Union (EU) – The European Commission approved a proposed €750 billion (about $826 billion – 4.5% of GDP) stimulus package to help the European Union recover from a recession brought on by the coronavirus pandemic significantly through quantitative easing.
- Japan – The Cabinet of Japan approved a 117 trillion yen ($1.1 trillion) plus another supplementary budget of $1.08 trillion totaling $2.18 trillion (about 40% of GDP) to deal with a set of measures that includes quantitative easing to help for struggling companies.
- Indonesia – The Bank of Indonesia (BI) responded to the People’s Representative Council’s recommendation to print money up to Rp 600 trillion (S$55.3 billion – 5.0% of GDP) to support and finance the country’s economic slowdown caused by the COVID-19 pandemic. The Governor of IB indicated that the printing of money is only done according to the rules and coordination between the Bank of Indonesia and the Ministry of Finance and this essentially was transferred to the government and financial institutions through quantitative easing.
- South Africa – President Cyril Ramaphosa announced a record 500 billion rand (about $26.3 billion – 7.3% of GDP) rescue package to cushion the economic blow of the coronavirus pandemic. In an unprecedented move in March 2020, the Central Bank of South Africa started buying back government bonds from the secondary market to inject liquidity and prevent lending from seizing up.
CREATING MONEY VRS PRINTING MONEY
Central banks are either creating money or printing money (bank notes) to engage in QE. For example, The Federal Reserve of the US is creating dollars from scratch at an unprecedented rate while the Bank of Indonesia has printed money (new bank notes) to engage in QE. Creating money is different from printing money and the difference between the Fed of US and the Bank of Indonesia will bring home the point.
In the US, The Federal Reserve doesn’t literally print paper dollars. That’s the job of the U.S. Treasury, which also collects taxes and issues debt at the direction of Congress. At this time of crisis, the Fed instead makes large asset purchases on the open market by adding newly created electronic dollars to the reserves of banks. In exchange, the Fed receives large amounts of bonds (U.S. Treasury securities and agency securities).
When the Fed creates money through quantitative easing, banks get more dollars in reserve and are more prone to lend money without worrying about exhausting their funds because of a possible run on the bank in times of panic withdrawals. Such big purchases of securities by the Fed also effectively increase the money supply and drive down interest rates. This keeps borrowing costs cheap for those who need it.
In the case of Bank of Indonesia, the QE is being funded not by creating money but actually printing new notes to support and finance the country’s economic slowdown caused by the COVID-19 pandemic. The Governor of IB indicated that the printing of money was done according to the rules and coordination between the Bank of Indonesia and the Ministry of Finance and this essentially was being transferred to the government and financial institutions through quantitative easing.
INFLATIONARY EFFECTS OF PRINTING OR CREATING MONEY
If printing more money doesn’t increase economic output and it only increases the amount of cash circulating in the economy then it creates inflation. When more money is printed, consumers are able to demand more goods, but if firms have still the same amount of goods and services, then they will respond by increasing prices. Hence, printing money without a clear underlying asset can have a negative impact on inflation.
Some economists believe that money creation within the context of QE may also cause overheated financial bubbles fueled by too much easy money in the system. Creating too much money that chases too few goods can also lead to price inflation and decrease the purchasing power of a country’s currency.
Historically, high inflation didn’t however materialize the last time the Fed created money on a similar scale as part of its efforts to revive the economy of the US during and after the financial crisis of 2008 (great recession). To the contrary, an arguably bigger concern was the persistently low inflation that followed the significant creation of money by the Fed which eventually led to deflation or falling prices. The United Kingdom was also very successful in using quantitative easing (creating money) during the great depression of the 1930s. The case for US and UK offer a complete opposite reaction to the expectations of monetarist economists on inflation.
The author supports the view that creating or printing money should not necessarily create high inflation. The popular view of inflation stems from the Monetary Economist, Milton Friedman (1976 Nobel Prize Winner in Economic Science) who advocated that MV = Py where M is equal to the supply of money, V the velocity of money (or the average number of times each dollar bill is spent), P the average price of goods and services, and y the total quantity of all goods and services sold during the time period in question.
No economist disagrees with the basic equation MV=Py because when you hold V and y as constants then any move in money supply (M) will definitely cause price (P) to rise. Notwithstanding, the underlying assumptions are not always the case. For example, the monetarists view, assumes that the velocity (V) of money is related to people’s habits which is relatively constant but there is a great deal of evidence that the velocity of money is NOT constant. As one would expect, it tends to decline during recessions and pandemics when people do, in fact, want to hold more cash. Hence, a Central Bank should be able to create or even print money and still be able to manage inflation. Indeed, there are issues with the other assumptions bordering the definition and identification of money (M) in this modern credit-money economy and the fact that the economy automatically tends towards full employment but these are not the focus of this article.
LESSONS FOR GHANA
Using Domestic Sources of Funding Covid-19
In the 2020 Mid-Year Budget Statement of Ghana, the Finance Minister indicated that an estimate of GHc100 billion (about USD18.0billion) of spending and investment inflows will be needed to fully fund the initiatives of the government’s Covid-19 Alleviation and Revitalization of Enterprises Support (CARES) program from 2021-2023. Given the severe fiscal strains the Government is targeting funding at least GH¢70 billion of the GHc100 billion from the private sector, both domestic and external.
The author recommends that total funding should come from domestic sources and only foreign grants without any conditions should be included. The challenge for government is usually not the domestic debt but the external debt which impacts negatively on our fiscal position due to the forex implications on interest and principal repayments.
From the analysis of funding sources of various countries, it appears that all of them continue to use almost 100% funding from domestic sources. Funding from domestic sources using quantitative easing provides vicious cycle which allows funds to stay within the country and grow the economy. Most of the debt created temporary through quantitative easing in the developed economies tended to be permanent or written off by successive governments so why shouldn’t developing nations also look inward for funding?.
For example, currently the Fed is creating dollars to buy government debt in the form of securities previously issued by the U.S. Treasury. The Treasury then pays the Fed what it owes in interest on those securities. In turn, the Fed is required by law to return the profit it makes to the US Treasury. Using the same analogy for Ghana, will mean that the Bank of Ghana (BoG) buys GoG securities issued by the Ministry of Finance (MoF) on behalf of Government, then the MoF will pay interest on the GoG securities purchased by the BoG and thereafter BoG returns its profit back to MoF as dividends and this becomes a positive vicious cycle. This has the potential to not only to grow the economy but give GoG a buffer and fiscal space to do other things.
Domestication of the Economy
According to the Finance Minister, COVID-19 pandemic has reinforced the importance of the government flagship programmes. It has also exposed new vulnerabilities and the need to scale up some programmes and introduce new interventions. The responses to some of the emerging issues are in the areas of food security, and support to SMEs and the manufacturing sector. To this end, Government plans to take several measures to help businesses to meet the challenges of COVID-19 and to protect workers.
No doubt, the coronavirus pandemic has increased the consciousness of domesticating the economy. It is obvious that the country needs to improve local production rather than depend on foreign imports. Local production will help not only to create employment and increase income but it has the potential to stabilize our currency (Cedi).
The budget estimate of GHc100 billion for CARES by government for 2021-2023 must be strategically spent on boosting local production without any foreign intermediate goods so as not to contribute to the depreciation of our currency (Cedi) and thereby cause imported inflation.
Market Liquidity and Promotion of Confidence
Quantitative Easing fosters recovery from an economic shock, it ensures market liquidity and promotes confidence in the financial system. Unfortunately for Ghana, some aspects of the country’s financial services sector were in distress due to lack of liquidity before the advent of Covid-19 pandemic. While the tier 1 banking sector seem to be doing well after their recapitalization and financial cleansing by BoG, the other tiers namely, Savings & Loans companies, Finance Houses, Microfinance Companies, Fund Management Companies and the other operators within the non-bank financial sector are still suffering from the liquidity shock to the system.
According to the Finance Minister, as at the end of first quarter 2020, a total amount of GH¢13.6 billion (3.5 percent of GDP) has been spent on the resolution of failed banks, Specialized Deposit-taking Institutions (SDIs), Micro Finance Institutions (MFIs), the establishment of the Consolidated Bank Ghana Limited (CBG), as well as the capitalization of the Ghana Amalgamated Trust (GAT)
Additionally, with the President’s directives to fully pay all depositors whose funds were locked up with the failed SDIs and MFIs, an amount of GH¢5 billion was spent. This brings the total expenditure on financial sector interventions as at June 2020 to GH¢18.6 billion (4.8 percent of GDP). Government has also committed an amount of GH¢3.1 billion (0.78 percent of GDP) towards supporting investors in failed asset management companies regulated by the Securities and Exchange Commission (SEC). This would bring the overall cumulative total Government expenditure for the failed financial institutions to GH¢21.62 billion.
While these are significant efforts from the Ministry of Finance, it must be encouraged to do more by settling all the depositors funds locked up in the failed financial institutions to restore trust and credibility in the financial sector. The BoG has also shown commitment to the Asset Purchase Programme up to GH¢10 billion in line with the current stabilization phase of the COVID-19 pandemic. The BoG must also be encouraged to engage more in quantitative easing by creating more money to help provide market liquidity and improve confidence in the financial services sector.
In conclusion, the MoF should focus on funding its covid-19 programs using domestic sources and not foreign loans and the Ministry must lead an ambitious domestication of the economy through strategic resource allocation to boost local production and increase employment and income.
BoG should create more money in ways that will have underlying assets to check inflation. Most of the world’s greatest central banks have embarked on serious quantitative easing to solve the economic setback of coronavirus pandemic and the author recommends the Bank of Ghana to do same to improve market liquidity and confidence in the financial service sector especially within the lower tiers such as Savings & Loans, Finance Houses, Microfinance Companies, Asset Management Companies and other non-bank financial institutions.
It is important to stress that quantitative easing through creating money and/or printing money can be done without creating high inflation especially during recessions caused by pandemics as indicated in the unrealistic assumptions of the quantity theory of money put forward by monetarists. Notwithstanding, it is the interaction between fiscal and monetary policies that determine inflation and therefore the cooperation between BoG and MoF are central to keeping inflation on target.
The writer is the Founder/CEO – Cidan Investments Ltd.