Notes 4 Flashcards
Impact of QE
- Central Bank prints new money
-Uses the money to purchase assets (bonds, corporate bonds, equities) - this causes the asset prices to rise in each of the markets. bonds yields fall
-further ripple effects
-bond investors who sold bonds, want to hold other assets in their place so buy corporate bonds/other assets, push price up - corporate bond investors who sold to the bond investors, want to hold other asset, buy other assets (eg equities)
- Speculators will likely purchase in anticipation of the increased demand for these assets and the consequent price increases
-Corporates want to take advantages of the low corporate bond yields and issue more bonds.
-particialy offset the price raise.
-In some cases, the proceeds of the bond sale used to buy back their shares, further increase price in equity markets.
-QE likely lead to higher asset prices in general.
QE impact on asset prices
- cause asset price inflation
- centrals banks purchases of bonds pushes up prices
- ripple of asset prices
- sellers of the bonds look to replace the,
- those sellers in turn look to buy replacing assets
- Speculation leed to further asset price inflation
QE impact on wealth and economic activity
- asset owners wealth increase
- those with no assets, no gains, relatively worse off not having participated in the windfall.
- increase in market inequality
-economic growth increase - wealth gains - higher purchasing power, when spent economic activity , employment
- no assets, gain from more jobs created, money trickles to them,
-overall impact unlikely to be significant, possibly transitory if the asset prices revert to their mean levels in time.
QE impact on price inflation:
- retail price inflation rates stay low
-less wealthy people not see any significant gains - retail price inflation may fall, or be worse off,
- mean average demand for a normal basket of good fall, result lower prices.
QE impact on wages:
- nominal wages see small/marginal gains
- economic growth impact unlikely to very significant
- demand pull effect -small
- most of the increase in employment is in the service industry to service those with greater levels of wealth.
- those jobs poorly paid
- real wage increase very small, due to low inflation
- due to increased asset prices the purchasing power of those real wages may be lower
QE impact on bank lending:
- banks have more cash from selling bonds to central banks.
- banks - able to lend more.
- only lend to those who they think will repay the loans ( those who have greater levels of assets, as they become wealthier)
- low interest rates - caused or maintained by QE, have detrimental impact on banks lending margin loans , dampens the overall willingness of banks to lend
what are the impacts of QE? (titles only)
- bank lending
- wages
-price inflation
-wealth and economic activity
-asset prices
Risks arising from QE
- likely lead to significant bubbles in asset markets.
- low interest rates - future equity earnings discounted using very low interest rates.
- if asset prices are overvalues then due to the impact of QE, future expected return assumptions are likely to be much lower than historical data.
- QE is also likely to impact corporate finance decisions, meaning poor projects will likely get finance, as they show profitability using low interest rates, even though they might not show profitability under normal interest rates.
- aspect highlighted by John Mills in his “credit cycles and the origin of Commercial panics”
influence of media on QE
- financial markets can be directly influenced by political and fiscal landscape.
- Specific polices on taxation may favour some industries at the expense of others, or cause individuals and companies to act in a certain way to maximise benefits.
- markets adapt quickly to news of new policies
- period of significant volatility while substantial new information is proceed by market participants.
- indirectly affected
eg QE, increase in inequality, disadvantaged categories become brutalised, increased nationalism, protectionism of globalisation and trade.
eg UK - brexit and election of Donal Trump in USA
when analysing influences what factors have greater significance than they might have done hisotiralcay
- an analysis of wealth
- an alalysis of market value of equities and bonds
- the marginal propensity to spend increases in wealth
what are the aims of regulation
- correct market inefficiciences and to promote efficient and orderly markets.
- protect consumers of financial products.
- maintain confidence in the financial system
- help reduce financial crime
(all related)
attempt to develop a system which can achieve the above aims at a minimum cost so that the benefits (difficult to measure) outweigh the costs.
Direct costs - administer the regulation, indirect costs arise from changes in behaviour.
- need for regulation of fincancial markets, greater than the need of regulation for most other market participants, because of the importance of the financial system and damage that would be done by a system financial collapse.
What are the established theories in financial economies
- Efficient Market Hypothesis (EMH)
- Capital Asset Pricing model (CAPM)
what does EMH state
Efficient Market Hypothesis (EMH)
- that an assets price fully reflects some (or all) available information.
- Consequene that stock is always traded at their fair value so it is impossible to consistently pick individual stocks that will be beat the market.
-Outperfromance is only possible by taking greater systematic risk, which roughly is the equivalent to saying that CAPM holds (capital asset pricing model)
SML what does it do
- Security Market Line
- plots the expected rate of return on an individual security as a function of systematic risk based on the theory of CAPM
Critical Analysis of the use of statistical techniques
- correlation does not imply causation: simply because two things occur together it does not mean that either one has influenced the other or caused the other.
- where correlation does exist between two items, any causation may be the reverse of that proposed. Eg a statistical evidence showing that noise from roosters and sunrise is highly correlated, but saying that rooters cause sunrise would be erroneous.
- danger of omitted variables that can lead to spurious selection.
- samples might not be as random as they initially appear.
- co-intergation of other economic problems can exist, invalidating the underlying statistical assumptions and invalidating the results.
