More thoughts on quantitative easing from Morgan Stanley

The following post is up on Morgan Stanley’s website and highlights the degree to which money printing has become the policy tool of choice used by central bankers with which to fight this deflationary threat.  I have highlighted the whole paragraph on the inflationary risk of all of this.

Central banks that have adopted QE have used very different strategies, except for one which they have all shared – they have managed to surprise markets with almost every announcement. Since our last write-up (see “QE2”, The Global Monetary Analyst, March 4, 2009), monetary authorities in the UK, Switzerland and the US have delivered hefty surprises to the market by introducing larger-than-expected or significantly enhanced programmes. The Bank of England put £75 billion of the £150 billion tranche approved by the Treasury to use on March 5, most of it to be used to purchase gilts. The Swiss National Bank announced on March 12 that it would buy corporate bonds as well as foreign currency – specifically the euro. Finally, at its meeting on March 18, the FOMC delivered a hefty increase in its MBS purchase programmes (from US$500 billion to US$1.25 trillion) and introduced a US$300 billion programme to buy Treasury securities.

We are optimistic about the traction from QE… QE is not a panacea for economic ills, but we believe that it can work in conjunction with the many other programmes that are attacking the problem from various angles. These actions from major central banks are a continuation of their earlier aggressive easing of policy rates and their willingness to use any and all available means to pull economic growth up by its bootstraps. The size of these programmes to purchase assets outright as well as the demonstrated commitment of central banks to persevere with unconventional measures are integral parts of the policy package.

…but we also see higher risks now. The increase in the size of the active QE programme directly increases the potential policy traction in much the same sense that pushing policy rates lower increases the monetary stimulus. However, the size of these programmes also raises risks in two ways. First, it increases the potential size of losses that the central bank and its guarantor (the government) may have to bear. Second, unwinding such massive purchases of assets will act like a sizeable contractionary monetary policy shock. While the chances of QE making a significant impact on the economy have increased, so have the risks associated with managing and correctly unwinding these programmes…

QE in the G10. The G10 aggregate policy rate is already close to zero. It is therefore not surprising that QE is being either considered or implemented here, depending on the need for further policy action. The Swiss National Bank announced its active QE package (purchases of corporate bonds and FX) only on March 12, but it has been using passive QE since November 2008. Both Norway and Sweden have allowed their monetary base to grow since September and October 2008, respectively, in sync with increases of the monetary bases of the G4 central banks. The Bank of Canada, having cut its policy rate to 0.5%, seems to be readying itself to use “credit and quantitative easing”. Our strategists believe that QE could be in action there sooner than markets expect.

Perhaps the most crucial decision on the adoption of QE clearly lies with the ECB. The ECB, like the other major central banks, has instituted a passive QE regime since September 2008. Our ECB watcher, Elga Bartsch, believes that the ECB is unlikely to go down the path of active QE, but would be quite willing to extend the term on repo operations. These facilities were put in place at an early stage in the crisis, have worked well and have been copied by other central banks around the world. Also, the ECB may widen the pool of eligible collateral yet again by lowering further the required minimum rating for eligible assets. There is still room to cut rates, and our forecasts project the refi rate at 0.5% in 2Q09. However, given the downside risks to growth, the adoption of active QE can clearly not be ruled out. If the ECB does decide to purchase assets on an outright basis, it is likely to prefer corporate securities to government bonds in order to ease credit conditions (for more details, see QE or Not QE? by Laurence Mutkin, March 20, 2009).

Now, I am going to stop there because I want to introduce a few words by Ambrose Evans-Pritchard of the Telegraph regarding the ECB’s quantitative easing strategy. Do read the rest of Morgan Stanley’s research at the link in sources.

ECB is clearly alarmed by the outright contraction of credit. Loans to non-financial corporations fell in February (minus €4bn).

Yes, the M3 money supply is still up 5.9pc year-on-year, but that is backward-looking. M3 growth has collapsed. The credit crunch that was not supposed to exist in the eurozone is already well advanced.

The bank’s vice-president Lucas Papademos (ex-MIT, a heavy-weight) said: “It may be warranted that the central bank purchases private sector bonds to enhance liquidity. No decision has been taken, but it is a possibility that could improve the markets”.

“Potential measures could include an extension of the maturity of the central bank liquidity provided to banks and purchases of private debt securities in the secondary market”.


Nout Wellink, governor of the Dutch central bank, in turn said there is now “an increasing risk of deflation”.

Thank you Mr Wellink.

ECB president Jean-Claude Trichet has been insisting for month after month that there is no risk whatsover of deflation. At least a million workers are going to lose their jobs over coming months unneccesarily because of this blind refusal to face the reality of what is happening in the world.

(Or perhaps that is unfair to Mr Trichet’s boss – Bundesbank chief Axel Weber. One suspects that Mr Weber does indeed understand what is happening but knows that once the ECB starts buying bonds, it is on the slippery slope to an EU debt union – at German expense. The pressure to bail out Club Med governments may become unstoppable. He is right about that.)

Mr Wellink went on to admit that the ECB had screwed up royally by raising rates last July in response to a phoney inflation scare (oil futures speculation) at a time when much of the eurozone was already in recession.

“In hindsight, this measure was based on a faulty estimate of inflationary risks and real growth prospects.”

Bravo, Mr Wellink. This is the first time – to my knowledge – that any ECB governor has admitted any fault in what must be described as the most remarkable act of monetary primitivism in modern times, or indeed admitted any error on anything. One was beginning to think they were incapable of self-criticism.

Thank goodness for Dutch honesty. The ECB will be much stronger for it. Chippy central banks do not command respect.

It has taken a long time to get here: a lot of damage has been done. A German contraction of 6pc to 7pc (Commerzbank forecast) is already baked into the pie this year. German unemployment may reach 5m in 2010 (RWI Institute).

Ireland’s GDP has already dropped 7.5pc (year-on-year to Q4). Eurozone Industrial output fell 17.3pc in January (y/y). It was down 31pc in Spain. This is a greater fall than anything suffered in Spain over a 12-month period during the 1930s.

Now, I am not going to take a view here, but I think you know my unease with printing money. And I do think the excess liquidity in the system will not be mopped up in due course when the global economy recovers.

What I want to focus on is the importance of the ECB’s move to a more explicit QE policy. In my view, this puts every major central bank into the same category i.e. printing money to ward off deflation. Irrespective of one’s ideological bent, one must this should mean recovery sooner rather than later. Whether this anticipated recovery is inflationary or ephemeral remains to be seen.

As for Evans-Pritchard’s piece, he does go on to say:

Sadly I have little confidence that the ECB will undertake QE with adequate dispatch, but at least they seem willing to swallow their pride and start to do their part to mitigate the global depression that we are already in.

If they move fast enough they may even prevent the eurozone breaking. Big if.

We all know he has an anti-Euro bias (one I often share), so you have to take his comments with a pinch of salt.

My conclusion is that we mustn’t discount the very real possibility of a cyclical upturn in 2009. While my base case view sees weakness through the end of the year, signs of reflation in asset prices, commodity prices, plateauing claims numbers, and consumer spending are certainly already evident.

Certainly, I still foresee some major writedowns and heavy challenges in stoking credit growth in North America and Europe. But, I will keep an open mind and look for evidence on both sides of this argument.

QE2 – Size Matters – Morgan Stanley
Europe fetches the monetary helicopters, at long last – Ambrose Evans-Pritchard, Telegraph

  1. hbl says


    Your open mind on these topics is refreshing.

    Personally I don’t see how QE can do much to fight deflation — when Japan tried it in the early 2000s didn’t it actually help accelerate deflation as more debt was paid off? But I do see that QE could help keep yields low. Also the inflation arguments could become a lot more convincing to me if policy changes such that increases in base money are targeted to those most likely to spend it.

    My last comment on a previous post never showed up outside the /comment-page version of the URL, I’m not sure why.

  2. Edward Harrison says


    I am sceptical about easy money being the cure-all here. But, at a minimum, when everyone is printing money, that money has to go somewhere.

    As for the comments, you’ve probably noticed that my site has been erratic over the past week. It looks like that problem is now fixed. Sorry to lose your comment, though. Cheers.

  3. Glen says


    I wonder if Japan’s experience with QE was different that what we might expect. Japan engaged in QE in isolation. When everyone is doing it, it is a whole different ball game. Perhaps the only way to measure the effects is to look at relative commodity prices (weighted).

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