Central banks have plenty of ammo but there’s confusion on how they fire
WHEN economic crises strike it can take a while for economists to keep up. But one of the confusing outcomes of events since 2008 has been policymakers presenting established policies – such as what is now being called quantitative easing (QE) – as being novel, and policymakers and commentators using different terms to mean the same thing (and indeed the same terms to mean different things).
When asked if he was engaging in QE, Mario Draghi, president of the European Central Bank was right to reply that “every jurisdiction has not only its own rules, but also its own vocabulary”.
For years, economists have accepted that something called “open market operations” are a key tool in central banks’ arsenals – even though they may not have been used especially frequently prior to the crisis.
The typical textbook definition states that central banks can use such open market operations to buy and sell government bonds from commercial banks with newly created money to influence the interbank market and hit a target short-term interest rate. Does that remind you of anything? Open market operations are of course the old name for our supposedly new friend QE – sometimes, giving an old idea a new name can have a huge impact on how it is received and debated, especially when the public and media are unaware of its history.
Why QE or open market operations? Simple: short-term interest rates cannot be negative so at some point a rate-cutting central bank can become constrained by their “zero lower bound.” But monetary policy doesn’t then become ineffective. There are still plenty of options available to the central bank. Here are four.
1. Qualitative easing – the central bank changes the quality of assets bought and engages in the purchase of assets other than government bonds. This could include private bonds or even junk bonds if they wish.
2. Credit easing – the central bank changes the list of institutions that it buys assets from. Instead of only dealing with a particular set of commercial banks they could buy assets direct from the non-bank commercial sector, or even from specific businesses such as SMEs. The central bank essentially becomes an investment vehicle in private debt.
3. Operation twist – the central bank can change the maturity of the assets being bought, and can try to flatten the yield curve by purchasing longer term assets.
4. Quantitative easing – the central bank targets the quantity of assets bought rather than the price (i.e. the interest rate).
If nothing else, this reveals that quantitative easing is nothing new or exotic, it is simply printing money to buy a pre-specified amount of bonds. But the further question is what type of bonds, what duration, and who from? These are the policy discussions that are taking place right now, and are less of a ragbag than they appear.
Anthony J. Evans is Associate Professor of Economics at ESCP Europe Business School. His website is www.anthonyjevans.com, and you can email him at
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