Pratham is currently pursuing his Bachelor's in Business Administration and loves the world of finance and is here to share his opinion.
Does our economy run on steroids?
Steroids are man-made drugs(or chemicals) that are designed to alter the hormones to act in the desired way. But, how is this biology lesson related to the economy?
What if I told you that the US economy, was put on steroids by the Federal Reserve after the financial crisis of 2008. Sounds crazy, doesn't it?
After the crash, when markets around the globe were touching new depths the need for intervention from the Federal Reserve became a must to prevent the entire monetary system from collapsing. The policy they opted for was Quantitative easing as an unconventional way out of the crisis.
Discarding all the technical jargon.QE is a policy put in place by the Fed to bring out the printing press and inject cheap liquidity within the economy. However, this wasn't the first time a government introduced such a policy they are all around us in the form of Special economic packages, Bailouts, Economic Stimulus Packages, etc.
The illustration can help one understand how Quantitative Easing helps in boosting the economy. But what were the reasons for opting for this policy?
The low-interest rates provide access to cheap liquidity which in turn helps in increasing consumer expenditure. This cheap liquidity also helps in boosting business as companies can now get access to low rate credit which helps in promoting business expansion.
More money supply means depreciation in the value of the currency as compared to other currencies(assuming the other currencies have an unchanged supply) which leads to the attraction of foreign investment because the investors can now get more for less(like more stocks for the same 10,000 rupees).
It also increases the export competitiveness of the goods in the global market as the products are less expensive due to lower currency value.
But this "Quantitative easing" in simple terms is increasing the money in circulation, in the market. Which leads to currency depreciation and causes inflation. The prices in the country start to rise and if left unchecked can also lead to hyper-inflation within the economy and what hyperinflation does is no news to any of us.
A higher money supply only makes sure that the government's balance sheet expands as one can control the amount of currency put inside the system not where the currency goes. Further, the central bank can not force banks and other financial institutions to use the newly injected money.
Quantitative Easing is implemented when the interest rates in the economy are at rock bottom and the government further wants to decrease interest rates on the long-term assets, this triggers a fear of the economy facing a trickle-down effect shortly.
FED AND QE
The federal reserve for the past decade has been using Quantitative Easing as a way to keep the economy afloat. This first started back in 2008 when to prevent the economy and the entire financial system from crashing US government issued a bill of 800 billion dollars to buy real estate and other assets so the banks and other financial institutions stay in business.
However, this policy was only given a short-term relief to the government as after the prescribed period of around 10 months mark again started coming down as steroids(cheap liquidity) created artificial demand and the economy became addicted to it.
Due to this a second phase came and went then a third where the balance sheet of the federal reserve inflated from less than a trillion in 2008 to 4.5 trillion dollars in 2014.
Fun fact- During the Covid-19 pandemic, the US government announced another phase of QE where the injection of 500 billion USD in US Treasuries and 200 billion USD in mortgage-backed securities was done.
However, one might wonder if all this printing and injection is nothing but another bubble like the subprime mortgage loans and lead to another crisis but this time bigger than the last. Yes, the entire policy is just kicking the block down the road as the federal reserve has an unlimited ability to print more currency and use it to cover all the toxic loans over and over again.
Many economists and researchers believe that Quantitative Easing was worth it as it was able to control two important indicators in the economy i.e. Unemployment Rate and Inflation. But can these numbers be trusted?
Quantitative Easing is stealing the purchasing power of the masses as the more currency in circulation the lower the value of the currency in our hands due to basic principles of demand and supply. Further, the constant rising prices in an economy are major because of these policies which provide free access to the central banks to print as much currency they want to and then use the taxes to pay interest on the currency they didn't even earn.
So, is there no way one can maintain his/her purchasing power?
Stay tuned to find out :)
This content reflects the personal opinions of the author. It is accurate and true to the best of the author’s knowledge and should not be substituted for impartial fact or advice in legal, political, or personal matters.
© 2022 Pratham Arora