Most nations are now reducing interest rates at a phenomenal rate to stimulate their economies and counteract a recession they are either in or are sliding towards. But what will happen if/when rates reaches 0%? What will they do then? One option is to actually break through the zero percent barrier and introduce a negative interest rate - which would basically be a tax on bank deposits. Perhaps savers would withdraw their deposits and spend them, however, it is probably more likely savers would withdraw the deposits and hoard their cash at home - thus reducing banks' liquidity. To counteract this, banknotes may even end up having 'best before dates' printed on them after which time they are deemed worthless! Thus forcing people to spend.A different option which could be used to maintain interest rates at 0% is 'quantitative easing'. It is a monetary policy tool, which means the central bank prints new money, in order to increase the money supply. 'Quantitative' refers to the money supply; 'easing' essentially means increasing. So, the central bank floods the market with cash in an attempt to stimulate an economy in recession and, importantly for 2009, to stave off deflation. The idea is that if the central bank floods enough cash into the market, it will set off the following chain of events:
1. Banks and other financial institutions will build up larger and larger cash reserves.
2. Banks will finally decide to loosen their lending standards to utilize their excess cash.
3. Individuals and companies will start getting the loans they are seeking.
4. The economy will begin to recover as people and companies begin to spend again.
Quantitative easing was used notably by the Bank of Japan to fight domestic deflation in the early 2000s after its property and stock bubble bursts. It was a groundbreaking experiment and took a long time to work because the Bank of Japan was slow to employ all of its policy options and spell out its goals in a credible fashion. In recent weeks, both Ben Bernanke, Chairman, the US Federal Reserve, and British PM, Gordon Brown, have hinted at employing different monetary policies in the near futre for their respective economies. However, it should be noted, despite the almost certainty now that many Western economies will face deflation next year, the inherent danger of flooding the economy with cash can be very high inflation in the longer term. In fact, 95% of all historic cases of hyperinflation begin during either a deflationary depression or deep deflationary recession. (The other 5% is brought about by political stupidity as in Zimbabwe).
Quantitative easing was used notably by the Bank of Japan to fight domestic deflation in the early 2000s after its property and stock bubble bursts. It was a groundbreaking experiment and took a long time to work because the Bank of Japan was slow to employ all of its policy options and spell out its goals in a credible fashion. In recent weeks, both Ben Bernanke, Chairman, the US Federal Reserve, and British PM, Gordon Brown, have hinted at employing different monetary policies in the near futre for their respective economies. However, it should be noted, despite the almost certainty now that many Western economies will face deflation next year, the inherent danger of flooding the economy with cash can be very high inflation in the longer term. In fact, 95% of all historic cases of hyperinflation begin during either a deflationary depression or deep deflationary recession. (The other 5% is brought about by political stupidity as in Zimbabwe).
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