With all that is happening in the banking industry these days and with predictions that the ECB will use a heavy dose of quantitative easing to help stimulate the Euro zone economy, many investors are wondering what QE is all about and whether it will help them in the long run.
QE is an rarely-used monetary strategy employed by government banks to help stimulate the economy when normal monetary policies prove unsuccessful. Under normal economic conditions, when a central bank wishes to keep the interbank interest rates at a certain target value, they buy or sell government bonds. In cases where these measures prove ineffective, a central bank will purchase long-term financial assets from private institutions and commercial banks so as to bolster their monetary base and reduce the yield on these assets. This monetization of government securities, which acts to raise the prices of those financial assets and lower their yield, is referred to as quantitative easing and it is basically used to help ensure that inflation does not fall below target and to kick start crawling growth.
QE Boosts Prices
Central bank stimulus moves such as QE help boost the prices of more risky assets, namely global stock markets. Another side effect of QE is a drop in the value of the issuing country's currency. In the current situation, the euro has already weakened in anticipation of today’s probable ECB's action , while recent QE in Britain and Japan has helped drive down the value of their respective exchange rates.
Although a falling exchange rate will help increase exports and thus boost economic activity, this may not always lead to the anticipated results as it can initiate a round of depreciations in neighboring countries, not benefiting anyone in the end.
Other QE Consequences
There are other possible consequences to QE. Take Europe for an example. Should a euro zone member state default on its public debt, as the Greek government has just done, all efforts to stimulate the economy could falter. In order to safeguard the national central banks, who are shareholders of the ECB, against potential losses from the implementation of QE at this time, it has been suggested that any bond purchases taken by the ECB should be made on the accounts of individual national central banks of the euro zone and each institution should keep these assets separately on its own balance sheet.
Some analysts see this move as a means for shareholders of the ECB to enjoy the benefits of quantitative easing (QE) without having to assume the inherent risks. But others view it as flawed thinking.
The ECB is ready to take on the responsibility of QE which it has done on a limited basis only in the past four years. But some members of two German banks may end up stymying these efforts or at least restricting them considerably. It’s anyone guess how Mario Draghi and his counterparts at the ECB will come through this time around.