Thursday, 15 September 2011

Coordinated quantitative easing – will intended actions lead to expected outcomes?

Coordinated actions were agreed by the European Central Bank, the Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank to save the European banking system from the US dollar liquidity crisis on Thursday, September 15. Three fixed rate tenders to repurchase eligible collateral with a maturity of approximately three months will be organized to provide dollar liquidity. Is this decision a strong signal to stop lending in the US dollars, or otherwise – incentive to provide more loans denominated in the US dollars?

European banks need the US dollars to fund dollar-denominated loans and other obligations. So, here we come to the QE3, the monetary policy to stimulate economy by additional injection of money. In this particular case, the agreement is achieved by the five major central banks. The coordinative actions to increase the US dollar liquidity in the markets set the depreciation trend of the US dollar. Moreover, this fact combined with the US Federal Reserve’s promises to keep low interest rates until 2013 creates a huge stimulus for investors to borrow further in the US dollars. According to that demand, banks may have great incentives to provide loans denominated by the US dollars and a closed cycle when more and more liquidity is required to sustain stability of the banking system may be established.

However, how much those decisions stimulate domestic economies? The depreciated US dollar should ease the US export while domestic economies of the rest parties are driven by domestic businesses conducted in their own domestic currencies. So, most likely provided the US dollar liquidity will not stimulate the other parties’ domestic economies.

Hence, once the US dollar liquidity issue is solved by the quantitative easing decision mentioned above, shouldn’t it be imposed restrictions to engage in new obligations denominated by the US dollars in the rest parties at the same time so, that the intended actions led to expected outcomes?