BY ANTONY MUTUNGA
The world was hit in 2007/2008 by one of the worst crisis ever; the Great Recession, which ended up affecting almost every country around the globe. The negative effects of the crisis saw individual economies decline further and further, in terms of growth, as the financial sector of the world economy had been highly affected. Different economies tried several policies but nothing seemed to turn the situation around, creating the need for new policies that would help revitalize economies and minimize the damage caused by the crisis.
As a result, some of the developed countries took a leaf from Milton Friedman’s book. Mr Friedman had the idea that exchanging money for financial assets would be able to overcome a downturn in the economy. Therefore, in order to survive the difficult times of low investments and high unemployment rates, the individual governments through their central banks decided to create money and use it to acquire financial assets such as long term bonds and stocks from banks which in turn would be expected to pump more money in the economy. This is what is referred to as quantitative easing (QE).
Even though it became a popular jargon around the world during the time of the Great Recession, this policy has its roots further than that. A very similar policy to quantitative easing was implemented in the United States during the Great Depression, which took place in the 1930s. In addition, the Bank of Japan (BOJ) also used a similar policy in the 2000s when their economy was experiencing a recession.
The policies were recorded to be successful in both scenarios however; they were not able to do away with every problem to yield the desired results. For example, when Japan used QE in the 2000s it was able to help stimulate their economy after a while despite the fact that it was not able to fight domestic inflation. This information was helpful to the US Federal Reserve, the Bank of Japan, the Bank of England, and the European Central Bank during the Great Recession as they were the first to adopt QE to mitigate the impact of the crisis.
The central banks moved to the policy after noticing that adjusting the interest rates on banks was not producing the intended results. The effectiveness of QE varied differently because even though the banks used a similar policy, they took different approaches. For example, the QE approach taken by the U.S focused on all the markets that were mostly affected by the crisis while the others focused much on the banking industry.
Despite the policy being able to help stimulate the economies after the crisis, it had other unintended consequences on the countries as well as the global economies. Even though the QE in the U.S caused the balance sheet of the Federal Reserve to grow from $870 billion in 2007 to $4.5 trillion in 2015 and reduced the level of unemployment, for instance, it also caused an increase in income inequality.
As a result of globalization, the world has become interconnected. Nowadays economies are integrated with each other because of trade and capital inflows. Emerging markets especially those in Africa have been the major winners as they benefit more from this. For instance, in the case of QE the money created causes excess liquidity in the economy, which sees most of it flow in developing countries. This is due to the fact that investments from emerging markets tend to yield more returns over the long run when compared to developed countries. This, for example, can be accredited as one of the reasons behind Kenya’s oversubscription of the Eurobond.
However, this flow of money from the developed countries has not been completely advantageous to the emerging and developing countries. In Africa for example the flow of money into the economies as a result of quantitative easing in the U.S caused volatility in the local currency that saw it appreciate as the dollar depreciated.
This was good news for the US as it stimulated more demand for their exports but on the other hand it created a problem for African economies that rely on revenue from exports. Countries like Kenya, Nigeria and South Africa tend to suffer as the volatility is felt when it comes to exchange rates. As it increases, it ends up affecting trade as well as long-term investments, which are crucial to the growth of these emerging countries.
Apart from this, the quantitative easing has also had an adverse effect on the global economies whereby it stimulated credit expansion. In doing so it encourages debt, because there is an increased money supply and low interest rates economies are encouraged to borrow more. Even though the money borrowed can help an economy grow, when it is borrowed in excess it leads to more debt, such as a government deficit, that causes the economy to further slowdown.
The flow of money into emerging countries also caused inflation especially in asset prices. This was as a result of the money flowing in the economies being used to invest mainly in financial assets such as stocks, bonds and real estates. As a result, this caused developing countries to experience a bubble in the industries affected which in due time is expected to burst, leaving a crisis. The high liquidity flow also caused inflation in commodity prices but the effect was relatively small as compared to the inflation on asset prices.
In addition, emerging and developing economies are about to be affected more as the U.S starts the unwinding of its quantitative policy. Governments from developing economies, especially those that depended on the capital flows, need to be ready for what consequences this will have on their economies and the global economy as a whole.
Since the quantitative easing policy is not popular in developing economies most of the people tend to ignore it. However, it is time for citizens in these economies to understand that when it is implemented in developed countries like Japan, U.S and England, it does affect them. Developing countries need to be able to prepare themselves to not only profit from the policy but to also prepare for any of the effects that come with it.