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Abstract
This article argues that quantitative easing (QE) led to significant changes in the global financial system that are not conducive to greater financial stability. Through a policy of reserve accumulation, QE did not have a direct impact in the creation of global liquidity through bank lending. It rather reinforced the statistical decoupling between base money and the money supply and between deposits and loans. However, QE did have an effect on the composition of global liquidity by altering the relative profitability of investing in different assets and in this way exerted a positive effect on the performance of the international bond market, to which the decline in bank credit due to the deleveraging of global banks in the aftermath of the crisis contributed. The growing role of the international bond market facilitated the expansion of the debt of both the financial sector and the nonfinancial corporate sector in developing economies but also has reinforced the role of the asset management industry in financial markets. Due to its concentration and interconnectedness, illiquidity, and procyclicality, the asset management industry poses important risks to financial stability.
Notes
As part of its response to the crisis, the Federal Reserve undertook also a series of lender-of-last resort measures at the national and international levels that included the provision of liquidity credit to institutions that were important from a systemic point of view, such as Northern Rock (September 2007), Bear Sterns (March 2008), AIG (September 2008), UBS (October 2008), Citigroup (November 2008), and Bank of America (January 2009); extension of credit to ease the liquidity problems of interbank markets; and the provision of credit to alleviate liquidity constraints and shortages in specific markets, including private funding markets, shadow banks, and credit markets (see Domansky, Moessner, and Nelson Citation2014). According to the Wray (2013), the Federal Reserve created 13 facilities/programs to deal with liquidity shortages and constraints. The lender-of-last resort interventions aimed at putting out the fire of the financial crises (Bernanke Citation2013: 100). QE was the “primary tool to try to bring the economy back after the trauma of the financial crisis” (Bernanke Citation2013).
The increase in reserves is accounted mainly by excess rather than required reserves. Between the start of QE operation until 2013, excess reserves represented more than 77% of the increase in total reserves. The increase in reserves began with the lender-of-last resort interventions, but QE is by far the biggest contributor to the expansion in reserves.
See Choulet (Citation2015).
See Song and Zhou (Citation2014).
See https://fred.stlouisfed.org/series/MULT. As the end of 2016, the value of the M1 multiplier was still below 1.
The following equations provide a simplified example, since it takes into account only the relationship between the FED and the banking system. As explained in the article, the institutions, such as money market funds, that held the majority of assets purchased by the FED could not trade with the FED. As a result, the banks acted as an intermediary between those institutions and the FED. The inclusion of three accounting identities (FED, banks, and say money market funds) make the example more realistic without changing the basic messages of our simplified case (see Standard and Poor´s Ratings Services (2013).
This example is based on the FED’s balance sheet. During the implementation of QE, government deposits did not vary significantly. The items that changed the most are reserves of depository institutions and Federal Reserve notes in circulation. These increased from US$867 billion to US$1.2 trillion between the end of 2008 and the beginning of 2014.
On the post-Keynesian endogenous money view, see for example, Moore (Citation1988), Palley (Citation2001), Lavoie (Citation2015), and Lavoie and Seccareccia (Citation2016). See also Mehrling (Citation2000).
As put by Kohn (Citation2009: 4): “ … the degree to which assets of different types and maturities are imperfect substitutes is central to understanding the large-scale asset purchase … of the Federal Reserve.”
Over the past decade, between 1995 and 2014, the global bond market has quadrupled in importance, increasing its outstanding volume from US$20 to US$86 trillion dollars. In 1995 and 2014, the outstanding volume in the global bond market outspaced the capitalization of the global equity market by US$2 and US$20 trillion respectively. Similarly, bond markets are more dynamic than equity and have become much more important to the real economy as a source of finance. Available data show that between 2000 and 2014 the average daily trading volume in the United States bond expanded from US$358 to US$730 billion. Contrarily, the average daily trading volume for equities was US$129 and US$126 billion in both years respectively.
The ratio of debt to capital (leverage) of global financial institutions hovered around 20 or more, which means that they finance over 95% of their asset purchases by issuing debt. Leverage tends to behave procyclically. The ratio between the rate of asset growth and the rate at which leverage increases is positive and statistically significant. Available evidence shows that the correlation coefficient between the two variables for a sample of major banks in the United States for the period 2000–2007 is 0.89. High levels of leverage create considerable opportunities for profit, since the more leverage there is, the greater the returns on capital. The expectation of increased returns provides an incentive for overleveraging. In the 2000 decade global banks were procyclical. This can be demonstrated by calculating banking returns. Return on equity (ROE), defined by the ratio between net income and assets, equals the product of the ratio between net income and assets and the ratio between assets and equity. Formally,
In turn, the ratio between net income and assets is simply the return on assets (ROA), and the ratio between assets and equity is known as leverage. Thus, the return on equity (ROE) can be expressed as the product of the return on assets (ROA) and leverage, so that the greater the leverage, the greater the returns will be. Formally,
These include JPMorgan Chase Bank, Citibank, Goldman Sachs, Bank of America, Wells Fargo, and HSBC.
The major asset manager firms include Blackrock, Alliance, Vanguard, State Street, Fidelity, AXA, JP Morgan Chase, Bank of New York Mellon, BNP Paribas, and Deutsche Bank. JP Morgan Chase, Bank of New York Mellon, BNP Paribas, and Deutsche Bank are also some of the major global banks.
According to estimations by the IMF (2015: 108) for the United States, “70 percent of the variance of funds’ flows into assets is attributable to manager’s decisions, with the remaining 30 percent attributable to end investors.”
Additional information
Notes on contributors
Esteban Pérez Caldentey
Esteban Pérez Caldentey is chief of the Financing for Development Unit, Economic Commission for Latin American and the Caribbean (ECLAC), Santiago, Chile. The opinions here expressed are the author’s own and may not coincide with those of ECLAC. The author wishes to express his gratitude for the very valuable research support provided by Cecilia Vera and Manuel Cruz. The author is grateful for the very useful comments provided by Mario Seccareccia and two anonymous referees to an earlier version of this paper.