Gu Chaoming: The real cost of QE can only be felt when the interest rate is raised

time:2023-01-30 author:Trend
Gu Chaoming: The real cost of QE can only be felt when the interest rate is raised

As the Federal Reserve begins to raise interest rates, the huge economic costs of quantitative easing (QE) are finally emerging. U.S. CPI data for July showed that inflation had fallen to 8.5% from 9.1% in June, giving the market a bit of relief over the past few weeks. With inflation "appearing" to have slowed, some predicted the Fed could start cutting rates in 2023. There are also some optimists who believe that concerns about the high cost of raising rates will make the Fed more cautious about raising rates further. In July this year, former Trump economic adviser Judy Shelton wrote on a media website that the Fed would not be able to continue raising interest rates without the help of the Treasury Department; similarly, Sheila Bair, the former chairman of the Federal Deposit Insurance Corporation, believes that the Fed should quickly implement Quantitatively tighten QT to reduce the cost of rate hikes. Gu Chaoming, chief economist at Nomura Securities, pointed out that these remarks show that the market has finally realized an amazing fact: the full cost of the Fed’s previous large-scale QE will only be discovered when it starts to raise interest rates.

The frantic QE led to a surge in excess reserves

Gu Chaoming pointed out that in the recession cycle of the balance sheet, due to the weakening of the general expectations of enterprises, not only will they not borrow, but will continue to repayment or make up for impairment losses on assets. This has resulted in an economy without borrowers and a shrinking balance sheet. Therefore, in order to stabilize economic growth, we must first create a "borrower of last resort". This requires the government to step in for a massive fiscal stimulus. After Volcker, who was the chairman of the Federal Reserve in the early 1980s, brought the U.S. economy out of the stagflation quagmire through aggressive monetary tightening policies, monetary policy gradually replaced fiscal policy as the main tool for adjusting the U.S. economy. So economists are starting to argue that if a zero-interest rate policy fails to combat such a recession, the central bank should implement QE. But Gu Chaoming believes that they ignore the fact that when borrowers are under the weight of debt, no amount of QE can persuade them to borrow. With no borrowers, any money provided by the central bank would be stuck in the financial sector and never enter the real economy. Therefore, there is no reason why QE would lead to higher inflation or greater economic growth. One piece of evidence is that despite the Fed's QE after 2008, inflation did not rise and the economy did not grow. The economists went on to suggest that if QE didn't work, it was simply because it wasn't powerful enough. But after the Fed stepped up its QE efforts, the excess reserves of the major banks surged: the excess reserves held by U.S. commercial banks now surged to $3.02 trillion (12.1% of GDP), almost the level before the collapse of Lehman Brothers. 1600 times.

The surge in excess reserves makes interest rate hikes extremely expensive

Gu Chaoming said that in the absence of borrowers, QE is only a relatively “neutral” policy—— There are neither positive nor negative effects. But U.S. bank loans have been growing at an annualized rate of 11.9% each month since the fourth quarter of 2021. In response to this frenzied growth, the Fed reversed its previous stance and subsequently began tightening monetary policy. Koo believes that if the Fed raises interest rates with the current $3 trillion in excess reserves, banks will continue to increase lending, causing inflation to soar unless the Fed borrows the reserves itself and pays the banks interest. But even so, with inflation so high and real interest rates so low, only modest rate hikes may not deter borrowers. The U.S. bank with ample excess reserves is still competing for borrowers despite the Fed's sharp tightening of monetary policy, the Federal Reserve's Beige Book showed. This shows that monetary tightening is not very effective when there are ample reserves, unless the central bank raises the policy rate to an extraordinary level and pays the interest rate on all excess reserves, but there is a policy price for doing so, Ku said. will be extremely expensive. Judy Shelton also said the Fed earned $116.8 billion in interest income in 2021, but that income will drop to zero once the benchmark rate rises to 3.9%. The price of raising interest rates is that not only would it directly expand the fiscal deficit, but the interest on excess reserves (IOER) the Fed pays to banks would also exacerbate the problem by increasing excess reserves. Gu Chaoming also believes that, in fact, the central bank is paying interest to commercial banks to prevent banks from lending to the private sector, which increases the fiscal deficit. From the perspective of the average taxpayer, the central bank appears to be helping the financial sector make risk-free profits at the expense of taxpayers, making such a policy politically difficult to justify. IOER was introduced by the Federal Reserve in 2008 to implement QE. Without the IOER, the central bank's monetary tightening after the end of QE would have no impact. But with the Fed raising rates, the enormous cost of these policies is finally becoming apparent. All of these problems were foreseeable when QE was initially launched, but the position of most economists is that the scale of QE should be continuously expanded before QE has a real impact,” said Gu Chaoming, “It is the economists’ advice that led to It's getting so tricky."

The high cost of QE is also showing in Japan, the UK and Europe

Gu Chaoming also said that the Fed may do whatever it can to curb inflation, regardless of the cost. Market participants need to understand, however, how politically difficult and economically "ineffective" it is for the central bank to switch to QT after implementing QE. Currently, the U.S. is the only major economy where bank lending has grown so rapidly. Lending in Japan, the UK and Europe continued to grow slowly in the low single digits. However, he also believes that high inflation also continues to push real interest rates into negative territory in these economies, and the possibility cannot be ruled out that these negative rates will at some point prompt people to suddenly increase borrowing. We may eventually return to a world of low inflation (except in energy), but the timing is uncertain, he said. At this level, the central bank wants inflation to stabilize first, and then avoid paying such high interest rates on excess reserves. Fund flow data for Japan, the US, the UK and Europe show that the private sector in these economies has been in financial surplus (i.e. has been a net saver) since the 2008 balance sheet recession. If this continues, inflation may drop in the near future. It's hard to predict when this will happen, given the enormous uncertainty surrounding the supply side of energy and many other industries. Gu Chaoming concluded that central banks may be forced to continue to tighten monetary policy, while paying extremely high costs in the form of interest rates on excess reserves, which will also prompt central banks to accelerate the pace of tightening. ⭐Starred Wall Street news, good content not to be missed ⭐This article does not constitute personal investment advice, nor does it take into account the special investment goals, financial situation or needs of individual users. Users should consider whether any opinions, views or conclusions contained herein are appropriate to their particular circumstances. There are risks in the market, investment needs to be cautious, please make independent judgments and decisions. The huge economic cost of quantitative easing (QE) is gradually emerging
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