Quantitative Easing 2

"Negative impact"

Moreover, holding the official banking rates low for a long time has deflation impacts. As a banking rate stays low, requirement of internal rate of return on investment decisions starts declining. Theoretically, that leads banks to rend more, encourage innovation and entrepreneurship, and help economic recovery. In a practice, that encourage companies to stay in a segment where is no longer profitable, and other companies move into a business where is not profitable enough even on its proposal.


In a world where banking rate is zero, a company is willing and able to invest in a market where it can expect less than one percent return on equity. They tend to stay in existing businesses where they can expect at least minimum rate of return rather than challenging new markets where it is uncertainty. This conservatism cause cutthroat competitions and it drives the prices of goods down. This is the deflationary impact.


In the world of deflation, people postpone a purchase because they can buy it later for a better price. Low official banking rate discourages purchase itself and people’s willingness to shop and it encourage people to save more. Moreover, low interest rate itself leads people to save more.


Cutting official cash rate does not lead to cutting credit rates of individual customers, but it has effect on interest rates of their saving accounts. Their deposit interest rate declined faster than their credit rates (even if it does). If the interest rate has cut from 4% to 1%, the difference is only 3% annually. But the difference becomes almost 100% if you are saving up-to 20years for your retirement. In a form of 20years annuity, you have to save about 30% more annually to accumulate the same amount of retirement benefit that the 4% interest rate provides. The 3% change causes 30% difference in their annuity. This would lead people to save more for the future, rather than spend it now.

Quantitative Easing

Do you know the term “water intoxication”?? It is “a potentially fatal disturbance in brain functions that results when the normal balance of electrolytes in the body is pushed outside of safe limits by over-consumption of water” (retrieved from wikipedia.org). People are unable to survive without water, but too much pure-water could kill human-beings. This is the same as cash-supply for markets. Without the cash-supply, markets would not be able to survive, but when the amount exceeds a limit, pure-cash supply could kill the markets.

When we talk about the “quantitative easing”, we have to consider not only its quantity but also its quality too. That is because exceeding pure-cash-supply would kill a market. Humans need speedy installation procedure when they are seriously dehydrated, but after the emergency care, on the way to recovery, what they need is not hydration but rehabilitation. For a market, emergency cash injection is required in a moment of financial crisis, but pure-cash-supply does not help the economy to grow. Markets need rehabilitation for recovery. The rehabilitation means slow increase of an official cash rate.

When central banks practice quantitative easing they must set a cash rate above zero. Bank of Japan knows this from their experiences so they maintain the policy rate at 0.5%, even when Japan is moving toward deflation again. While the bank rate is close to zero, financial institutions are able to create profits by borrowing from a central bank and rending to a government (buying treasury bills). As you may not go to work if you can earn enough salary while you are in a bed, banks do not take risks if they can survive on the risk-free investment. To support the economic growth, societies have to support entrepreneurs to finance their future and societies must support big or small businesses to invest in new innovations. That is why central banks have to pull financial institutions out of Utopia of a risk free world, and enforce them to find green shoots. Even when central banks provide a huge amount of cash as quantitative easing, they must maintain the policy cash rate at above zero, preferably above interest rates of treasury bills.

When the official cash rate is high, it does not discourage banks to rend. That is because their business decisions depend on whether the investment is profitable or not and whether it is collectable or not. Even the capital cost is zero, corporations do not borrow if they have nowhere to invest, and people do not have houses if “they think” the prices is unaffordable. As long as the cash rate is below mode of expecting rate of return in the industry, quantitative easing is effective. If the cash rate is far below the mode, quantitative easing has more harm than good. Interest rates of treasury bills are called “risk-free rate”, therefore companies must have their expecting rates of return above it. In a practice of quantitative easing, policy cash rates should be near or above interest rates of treasury bills.