By Daniel Archibald | CFA
The concept of "money printing" and "quantitative easing" is not new in a world that has been slowly recovering from the financial meltdown of 2008. But, despite the recovery, ultra-loose monetary policy continues to be the setting of most central banks around the globe, with some even ramping up their efforts very recently. In this month's article, we took a quick look at the tools used by central bankers and the current levels of easy money in the major world economies.
Monetary Policy Mechanisms
Short-term Cash Rates
These rates are generally those at which banks lend to and borrow from one another for short periods of time (usually overnight), and is seen to have a powerful influence on longer term rates. In most developed economies this rate is technically set by the market (interbank), so in order for central banks to set the rate they want, they need to join the market ("open market operations") and create supply or demand, depending on which way they need the rate to move. There is still the chance that some transactions are carried out at a rate other than that "targeted" by the central bank, but discrepancies are generally limited.
Other short-term rates include crediting rates paid by central banks for reserves held, and central bank lending rates.
Long-term Rates and Other Markets
Though managing short-term rates can influence yields on longer dated securities such as bonds and mortgages, it may not be as effective as central bankers may like. Thus, in order to move longer-term rates in a way that might assist the economy, central banks can also participate in bond markets by buying or selling a quantum of such securities to effect the price and yield. This mechanism, known as "Quantitative Easing", is generally utilised if the targeting of cash rates is ineffective in bringing down bond rates, and is used across different types of securities including Government bonds, mortgage-backed securities and corporate debt.
Central banks may also look to affect the price of securities on other capital markets (e.g currencies, equities, property, commodities) by directly selling or buying these securities in their traded markets.
Bank Regulation and Requirements
In order to manage the lending practices of banks, central banks can either stimulate or deter activity through different regulatory mechanisms. The main one of these is reserve requirements, and is generally the minimum amount of cash that must be deposited by banks into their central bank reserve account. Some central banks do not maintain reserve accounts (e.g. Australia) but simply enforce the amount of internal reserves that need to be maintained. Capital requirements may also be used, enforcing how much leverage a bank can hold (i.e. how much debt, deposits or equity are used to finance loans). Central banks may also enforce other regulation such as banning risky loans or restricting the use of derivatives.
Monetary Policy by Country - June 2014 (in no particular order)
United States of America (Federal Reserve Bank)
- Federal Funds Rate (cash rate) = 0% to 0.25%
- Asset Purchase Program (quantitative easing) = Buying $45B per month of long-term US government bonds - currently reducing level by $10B every 6 weeks
Eurozone (European Central Bank)
- Main Refinancing Operations Rate (cash rate) = 0.15%
- Deposit Facility Rate (cash rate on reserves) = -0.10% ***That is correct! Banks can earn a negative rate (i.e. have to pay interest) for holding money with the central bank***
Japan (Bank of Japan)
- Basic Discount Rate (cash rate) = 0.30% ***Effectively 0%. Been below 1% since 1995***
- Asset Purchase Program (quantitative easing) = Buying 50T yen per year of Japanese government bonds and 1.3T yen per year of exchange traded funds and property trusts
United Kingdom (Bank of England)
- Bank Rate (cash rate) = 0.50%
- Asset Purchase Program (quantitative easing) = No new purchases since 2012
China (People's Bank of China)
- Base Interest Rate (cash rate) = 3.0%-3.5%
- Reserve Requirement Ratio = 20% for most banks (recently reduced by 0.5%)
- Currency = Managed peg to basket of major currencies
Australia (Reserve Bank of Australia)
- Official Cash Rate (cash rate) = 2.5%