The US central bank has launched a third round of 'Quantitative Easing' to help stimulate its economy. In this video John Carran explains what this means and how it could affect the New Zealand economy.
Interviewer: John, late last week, the US Federal Reserve announced something called ‘Quantitative Easing’ or QE3 - what is that exactly?
[Federal Reserve = the central bank of the United States]
John: QE is quantitative easing and what that means is that the Federal Reserve buys long-dated government securities, or mortgage-backed securities, and by doing that it adds to its balance sheet and needs to print money effectively to do that. So it buys long-dated securities and issues money to the economy.
Interviewer: Does this actually involve physically printing money?
John: They don’t necessarily physically print money, but what happens is money gets created in bank accounts, that then flows through the system.
Interviewer: How did the markets react?
John: Well the markets very much liked this QE3. There was a big rally in markets. The S&P 500 rose around 2% on the day that it was announced.
[S&P 500 index = tracks the share prices of the top US companies]
Now, they like it because that liquidity that goes in the system often has to find a place somewhere else in the financial markets and that’s either investing in equities – shares – or bonds, or cash. So a lot of that finds its way into the equity market.
It also helps because it will stimulate the economy and investors believe that it will stimulate the economy. And that’s good for shares.
Interviewer: What’s the impact been on the New Zealand economy?
John: Well, what QEs tend to do for countries, and what it has done for the United States in the past, is weaken its currency. Now, that’s because people think that inflation will pick up because of QE, and when inflation picks up in a country, it tends to weaken its currency. So what this has done, has weakened the US dollar, and so all other currencies tend to strengthen on the other side. So that’s what’s actually happened to the New Zealand dollar.
Interviewer: You mentioned that QE can have an inflationary impact; is that something we should be worried about?
John: I don’t think that that is a worry in the short term. Inflation currently is quite low and there is a lot of spare capacity in the United States economy. Factories aren’t running at their full capacity. There is high unemployment, so wage rates aren’t going to be bid up any time soon. Now obviously it is something that the central bank will need to look at further down the track as the economy recovers. And once it starts to see signs that that economy is recovering and inflationary pressures are starting to emerge, then they will start withdrawing that QE, which will entail selling some of those bonds that it now has on its balance sheet, and withdrawing some of that money, some of that liquidity, from the economy.
Interviewer: Is the New Zealand Reserve Bank likely to use quantitative easing?
John: I don’t think so. The main reason I say that is our economy is a lot better shape than the US at the moment. Our unemployment rate - although it is high from what it has been recently – it’s not up around 8% as it is in the United States. And most people are predicting our economy is going to pick up next year, to somewhere close to 3%. If our Reserve Bank did quantitative easing, that would just stoke inflation.