Quantitative easing (QE) is a process whereby a Central Bank, such as the Reserve Bank of Zimbabwe (RBZ), purchases existing government bonds (gilts) in order to pump money directly into the financial system. Quantitative easing (QE) is regarded as a last resort to stimulate spending in an economy when interest rates fail to work.

Background

Reducing short-term interest rates to encourage spending has long been the favoured policy option of Central Banks when dealing with the threat of deflation and recession. However, if aggregate demand fails to respond to ever-lower rates, another policy must eventually be sought. This is because nominal interest rates cannot fall below zero. Near-zero rates, together with cash hoarding by individuals, corporations and commercial banks, results in liquidity being trapped in the banking system, and contributes to financial crisis. So to help unlock liquidity (when a liquidity trap exists) and encourage banks to lend, the central bank embarks on QE.[1]

How does QE work?

QE can work in a number of ways, but essentially it works by raising asset prices, starting with Government Bonds, and then spreading out through the wider economy – this gives a boost to bank assets and current bank lending and creates a positive wealth effect for asset holders.

Although regarded widely as printing money, this is not the case since the central bank simply create the funds out of thin air. Printing money is more associated with funding government debt, rather than QE, which is directly pumping money into the economy to stimulate spending. When the RBZ adds credit to a bank's balance sheet, it gives it more than it needs to meet the Reserve Requirement. The reserve is the amount the RBZ requires banks to have on hand each night when they close their books. Bank lending starts to flow again, leading to increased household and corporate spending. Confidence rises as lending and spending increase. Aggregate demand increases and the economy moves out of recession. The inflation target is achieved – rather than fall below target as might happen in a recession or periods of low growth and poor expectations.[2]

Other Ways QE Stimulates the Economy

Quantitative easing stimulates the economy in three other ways.

QE Keeps Bond Yields Low

The central government auctions off large quantities of Treasurys to pay for expansionary Fiscal Policy. As the central bank buys Treasurys, it increases demand, keeping Treasury yields low. Since Treasurys are the basis for all long-term interest rates, QE also keeps auto, furniture, and other consumer debt rates affordable. The same is true for corporate bonds, making it cheaper for businesses to expand. Most important, it keeps long-term, fixed-interest mortgage rates low.

QE Attracts Foreign Investment and Increases Exports

Increasing the money supply also keeps the value of the country's currency low. This makes the country's stocks more attractive to foreign investors. It also makes exports less expensive.

QE Could Lead to Inflation

The only downside is that QE increases the central banks's holdings of Treasurys and other securities. The more dollars the central bank creates, the less valuable existing dollars are. Over time, this lowers the value of all dollars, which then buys less. The result is inflation.

Quantitative Easing in Zimbabwe

The downside of quantitative easing in Zimbabwe is that there are no checks and balances to inform on the amount to be printed and its purpose since the monetary policy framework has no autonomy from government. Currently quantitate easing is used to confiscate a portion of all export earnings, while the exporter’s local account is credited with virtual electronic money pegged to the interbank rate.

Zimbabwe exported commodities worth US$4,2 billion in 2019 and the central bank retained at least 35% of the total export proceeds amounting to over US$1,47 billion. As a result, billions worth of Zimbabwean dollars were injected into the local economy. Similarly the facility is used to monetise budget deficits thereby encouraging unrestrained government spending.

Factors leading to QE in Zimbabwe

Seigniorage

Seigniorage refers to the difference between the face value of issued notes and coins in the economy and the cost of printing them. The difference represents seigniorage profit earned from printing money. Governments world over, prefer issuing their own currencies partly because of this profit. The US, which has over US$1,5 trillion in notes circulating world over, continues to print more notes so as to benefit from such proceeds. In Zimbabwe’s case, the difference between the cost of printing and the value of ZW$1,3 billion in notes and coins is the profit earned by the government.

Flexible taxation

The Zimbabwean government collects various import duties, export fees and excise duty on DFI fuel in foreign currency. Additionally, the government also collects Pay-As-You-Earn (PAYE), Value Added Tax (VAT), Corporate Tax and Capital Gains Tax (CGT) from sectors that have been allowed to trade in foreign currency such as tourism, mining and other local companies indexing in foreign currency.

The inflation experienced in the Zimbabwean dollar helps to grow taxes levied in local currency especially the Intermediated Monetary Transfer (IMT) Tax, which has been handy in boosting government coffers. This explains the insistence by Treasury that the 2% IMT Tax is there to stay despite abolishing other austerity measures.

Domestic debt repayment

The ruling by the Supreme Court of Zimbabwe which declared that all debts incurred in US dollars on or before February 22, 2019 are payable in the local currency at the rate of 1:1 to the US dollar.

The biggest benefactor of the ruling was the government itself which had domestic debts amounting to US$9,5 billion in August 2018. This meant that the government will gradually pay less than US$550 million (Using the interbank rate on the day of the ruling) through printing the Zimbabwean Dollar. This would not have been possible if it was not for the organised chaos that preceded the Supreme Court ruling.

Funding govt subsidies

The central bank has maintained various consumption subsidies on fuel, soya, cooking oil, maize, wheat, electricity, agriculture inputs and others at the behest of the government. These subsidies are maintained to control prices in the local economy, but more importantly serve political interests despite the negative impact of such subsidies to the economy. Since 2015, the government has spent more than US$5 billion on subsidies in various sectors with Command Agriculture being the biggest beneficiary. These subsidies will be more pronounced as the country heads towards the 2023 harmonised elections.[3]

2020 Zimbabwe's Stimulus Package

Zimbabwe's Finance Minister Mthuli Ncube announced an $18 billion economic stimulus package in May 2020. The package includes a combination of fiscal measures and budget re-prioritization, and monetary measures in the form Quantitative Easing and lowering lending rates.[4] According to President Emmerson Mnangagwa in his address on 1 May 2020 he said: "Our Rescue and Stimulus Package of ZW$18 billion is therefore based on our aspiration to meet the diverse requirements of our national economy that include capacitating the micro, small and medium enterprises, as well as those in the informal sector. "These institutions have borne the worst brunt of the lockdown due to COVID-19 pandemic."[5]




References

  1. [1], Economics Online, Accessed: 14 August, 2020
  2. Kimberly Amadeo, [2], The Balance, Published: 1 June, 2020, Accessed: 14 August, 2020
  3. Victor Bhoroma, [3], Zimbabwe Independent, Published: 13 March, 2020, Accessed: 14 August, 2020
  4. Mthuli Ncube, [4], Twitter, Published: 13 May, 2020, Accessed: 14 August, 2020
  5. Costa Nkomo, [5], allAfrica, Published: 12 May, 2020, Accessed: 14 August, 2020