6. Monetary Policy and QE (Total 10 Points). From the Financial Times June 6, 20

Question

6. Monetary Policy and QE (Total 10 Points). From the Financial Times June 6, 2017, an article about the effects of quantitative easing (QE) written by Ros Altmann, an independent pensions and investment expert and former pensions minister in the UK. The article argues that QE, by holding interest rates down, has had very negative effects on the income of those who rely on their savings to plan for their retirement. It also argues that it has increased income inequality by increasing asset prices and holding down wages. By doing so, it has led to an increase in populism as reflected in recent elections. a) Is this a valid criticism of monetary policy in recent years? What would have happened to those with low income without Quantitative Easing? (5 points). b) The article also argues that there is an incredible risk now as these policies are reversed. “Now we come to the really big question — whether QE can be unwound. Would the market dislocation of selling trillions of dollars of bonds be too severe to withstand?” The article then compares two options that are available to central banks: 1. First one is “to allow the bonds they hold to mature without demanding repayment from governments. But this would amount to monetising fiscal deficits and would depreciate the currency and create inflation.” 2. The second alternative is “to change QE to morph into helicopter money. For example, could a future government use QE to finance social care, or public sector pensions— creating thousands of jobs in the process? Just print the money, buy the bonds issued to finance such spending, hold them in the central bank and hey presto, the financing is done.” The author believes that this second option is better because it addresses the issue of populism and benefits a larger proportion of the population. Do you agree with the analysis used by the author to conclude that the second alternative is better? (5 points)

Explanation / Answer

a. It is true that Quantitative Easing has led to fall in the level of interest rates in the economy which has led to increase in investment level however, the returns on savings have declined. But QE during the time of recession has helped in moving the economy from recession to recovery phase of the business cycle. Thus, it was one of the best options available to the Fed to overcome the recession of 2007-08. Wages of people with low income will be more without Quantitative Easing.

b. Recently, the Fed is selling bonds to reduce the level of interest rates in the economy in order to attract foreign investment. The second alternative is better among the alternatives mentioned above.It will address populism and address larger share of the population.

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