06/06/2019
Prof Chris Malikane
What is quantitative easing?
This is a central bank intervention in the economy where the central bank prints money to buy illiquid and sometimes bad performing assets (so-called bailout) from the commercial banks in order to improve the commercial bank's liquidity and thereby ease credit markets. But this intervention can be done for other financial institutions too, such as insurance companies or investment banks.
The point is not that banks need cash in order to lend. The point is that banks need to be liquid to meet their obligations to depositors and their lenders because remember banks have liabilities too.
The implications of the crisis
Now when the 2008 crisis occurred, many banks had loans that were not performing, e.g. households were failing to meet their mortgage obligations. The response was for the Fed to reduce interest rates to near zero so that the interest burden on households is reduced. The aim was to minimize defaults. The policy was not effective.
But because the interest rates were near zero, they could no longer be reduced further. What the Governor calls a "zero lower bound".
At the same time, as banks were facing defaulting loans, they reduced issuing credit into the economy. This reduced demand for goods and services and pushed inflation towards zero...threatening to create what the Governor calls a deflation (a situation where prices fall).
With the interest rate as an instrument now impotent, the Fed started printing money to, buying those loans from banks and creating liquidity to try to ease the credit markets.
Is QE Good Or Bad?
Here it is a matter of opinion and mine is that based on the above and in the case of advanced economies, QE is good. The lessons from advanced economies are that it is important that strict rules to allocate credit to targeted areas should be imposed under QE. What happened in the first round of QE was that executives in banks declared huge bonuses for themselves using QE money.
Secondly, what happened was that because the demand for credit by households and firms was low, some of the QE money went to emerging markets, which offered higher risk-adjusted rates of return, instead of being channeled into the US economy.
QE in SA?
The ANC is communicating a message that says the government is no longer capable of meeting its debt obligations given the current financial arrangements. It needs a bailout. This is what is being communicated. I fully agree...public debt now weighs so heavily on the government that both the public and private sectors are on a contractionary path...our only salvation is now exporting but this too is contracting...exports fell the sharpest this last quarter.
In 2009 I foresaw this predicament. I argued that SA should immediately print money to finance development and not rely on public debt, in order to safeguard productive capacity from being eroded by the sharp decline in demand.
Of course, this proposal was ridiculed. In one year we lost 1 million jobs without an outcry, and ever since then bouts of fiscal consolidation (reduced growth in Govt spending) have only helped weaken the economy.
In an emerging market to do our version of QE would mean the SARB printing money to directly pay off Govt debt or refinance some of it at below-market interest rates, or provide alternatively structured debt instruments to improve the liquidity of the govt balance sheet. That would include SOEs and DFIs as well.
The effect of this would be an increase in the money supply. My argument is that since there is excess capacity in the industry there are no demand pressures to create inflation. But what will have to be done is to have exchange controls and asset allocation requirements for banks so that the liquidity does not go to the foreign exchange market and collapse the currency.
It is doable...and it would have been even far better had we had a State Bank because that would take the mandate directly from Treasury and direct credit where it is supposed to go.
