What is Credit Easing?

The central bank conducts qualitative as a monetary policy tool to stabilize economic activity and improve economic welfare. This methodology involves purchasing specific assets to reduce interest rates. In addition, it modifies resource allocation that agents are unable to carry out on their own.

Key Takeaways

  • Credit easing shifts the central bank’s asset composition toward less liquid and riskier assets while maintaining the balance sheet size.Federal credit easing is a monetary policy used by central banks to increase credit availability in the economy. The banks buy assets such as bonds to provide liquidity during financial crises. This protects the economy from negative interest rates and promotes economic growth.According to the International Monetary Fund, qualitative easing causes sharp currency depreciation, high inflation rates, and a considerable decline in economic growth.

Credit Easing Explained

Credit easing is a method that entails purchasing specific assets to lower interest rates and increase liquidity in the target market by a central bank. Acquisition of default private securities is important to strengthen private credit markets. The approach focuses on the balance sheet’s asset side as opposed to quantitative easingQuantitative EasingQuantitative easing (QE) is an advanced monetary policy of central banks to stimulate growth in a stagnant economy by large scale buying of government bonds and other assets.read more, which focuses on the liability side. The goal aims to change the size and composition of central bank assets to influence lending conditions for individuals and enterprises.

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Financial institutions have enough resources to lend with the implementation of credit easing policies. People borrow from these institutions and spend it. This increases the money supply in the economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more. InvestmentsInvestmentsInvestments are typically assets bought at present with the expectation of higher returns in the future. Its consumption is foregone now for benefits that investors can reap from it later.read more also grow, paving the way for the creation of jobs. When people get jobs and earn money, it also increases the money supply in the economy.

Many central banks had employed credit easing during the global financial crisis . They made these measures initially intending to stabilize the financial systemFinancial SystemA financial system is an economic arrangement wherein financial institutions facilitate the transfer of funds and assets between borrowers, lenders, and investors.read more, but they eventually employed them to provide more accommodation near the zero lower bound. It is the situation in which the short-term nominal interest rateNominal Interest RateNominal Interest rate refers to the interest rate without the adjustment of inflation. It is a short term interest rate which is used by the central banks to issue loans.read more is at or close to zero. Liquidity trapsLiquidity TrapsThe liquidity trap is a scenario where the interest rates fall. Yet, the savings rate goes high, which tends to bring about ineffectiveness to the objective of expansionary monetary policy to increase the money supply. In this situation, people prefer holding cash rather than bearing a debt leading to virtual omission of liquidity from the market.read more form here, restricting the central bank’s ability to boost economic growth. Due to this, credit easing has been a wide success, particularly during severe financial instability when it prevented the collapse of financial markets and consequently bigger output losses. It also became useful to alleviate financial risksFinancial RisksFinancial risk refers to the risk of losing funds and assets with the possibility of not being able to pay off the debt taken from creditors, banks and financial institutions. A firm may face this due to incompetent business decisions and practices, eventually leading to bankruptcy.read more in emerging and developing countriesDeveloping CountriesA developing economy defines a country with a low human development index, less growth, poor per capita income, and more inclined toward agriculture-based operations rather than industrialization and business.read more.

Examples

Given below are two credit easing examples from the past

#1 – Bank of Japan:

In 2001, Japan experienced a mild deflationDeflationDeflation is defined as an economic condition whereby the prices of goods and services go down constantly with the inflation rate turning negative. The situation generally emerges from the contraction of the money supply in the economy.read more. As a result, they adopted a series of measures, including federal credit easing. In the second round, the lower long rates were primarily achieved by direct asset purchasing, for the policy duration effect was not employed until the comprehensive easing policy was announced. Then the Bank of Japan (BOJ) began a “comprehensive easing program” in October 2010. The Japanese government gave credit easing a higher priority than the preceding quantitative easing policy.

Japan had soon expanded the asset menu to include low-rated private bonds, ETFs, and J-REITs. The J-REIT dividend yieldDividend YieldDividend yield ratio is the ratio of a company’s current dividend to its current share price.  It represents the potential return on investment for a given stock.read more, in particular, responded strongly, and the J-REIT index bottomed out shortly after BOJ announced the BOJ J-REIT purchase. Later, Long-term interest rates eventually fell due to the policy duration effect. In the first wave of unorthodox policy measures, this was augmented with quantitative easing policy. Lower long rates were mostly accomplished through direct asset purchases in the second round, as BOJ did not use the policy duration impact until the comprehensive easing program was announced.

#2 – The Bank of England:

The Bank of England (BOE) established the “Asset Purchase Facility” in January 2009 after the financial crisisFinancial CrisisThe term “financial crisis” refers to a situation in which the market’s key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors.read more of 2008. It initially bought commercial debt with revenues from the Debt Management Office’s short-term Treasury billTreasury BillTreasury Bills (T-Bills) are investment vehicles that allow investors to lend money to the government.read more sales. This policy measure can be classified as credit easing akin to fiscal operations. The BOE announced its quantitative easing program in March 2009, announcing that it would buy $200 billion in long-term government bonds, or 14% of the nominal GDPNominal GDPNominal GDP (Gross Domestic Product) is the calculation of annual economic production of the entire country’s population at current market prices of goods and services generated by four main sources: land appreciation, labour wages, capital investment interest, and entrepreneur profits calculated only on finished goods and services.read more, well exceeding the size of the freshly issued 2009 bond. In October 2011, in response to sluggish domestic demand, the BOE increased asset purchases by $75 billion.

The BOE’s quantitative easing program differed from the BOJ’s in that it targeted non-bank private sector asset acquisitions, such as pension fundsPension FundsA pension fund refers to any plan or scheme set up by an employer which generates regular income for employees after their retirement. This pooled contribution from the pension plan is invested conservatively in government securities, blue-chip stocks, and investment-grade bonds to ensure that it generates sufficient returns.read more, rather than directly expanding bank lending. However, both the credit easing examples demonstrate qualitative measures Used to avert financial crises.

Use of credit easing

According to the IMF(International Monetary Fund), qualitative easing causes sharp currency depreciationCurrency DepreciationCurrency depreciation is the fall in a country’s currency exchange value compared to other currencies in a floating rate system based on trade imports and exports. For example, an increase in demand for foreign products results in more imports, resulting in foreign currency investing, resulting in domestic currency depreciation.read more, high inflation rates, and a significant drop in economic growthEconomic GrowthEconomic growth refers to an increase in the aggregated production and market value of economic commodities and services in an economy over a specific period.read more. The use of credit easing hence must be with caution in emerging and developing economies. Instead, countries should enhance financial supervision and regulation and build a robust macro-prudential policy to reduce financial market vulnerabilities. Monetary authorities will be able to take corrective action sooner rather than later due to tighter oversight and regulation.

Credit Easing vs. Quantitative Easing

Credit Easing and Quantitative Easing (QE) are different from each other in the ways given below:

Credit easing has only one goal- to jumpstart the credit markets. The reserve base consists primarily of money and other liquid assets. Both involve the idea of expansion of the central bank’s balance sheet. However, a purely QE approach focuses on the level of bank reservesBank ReservesBank reserve is the minimum fund limit the commercial banks and other financial institutions have to maintain as per the central bank’s guidelines. Each bank preserves such funds either with the large banks or Federal Reserve Bank facility; or in a vault on-site.read more. In the case of joint QE and CE implementation, CE is more effective than QE at raising corporate prices because the price sensitivity of a corporate bond to its purchases is far higher than the price sensitivityPrice SensitivityPrice Sensitivity, also known and calculated by Price Elasticity of Demand, is a measure of change (in percentage term) in the demand of the product or service compared to the changes in the price. It is used widely in the business world to decide the pricing of a product or study consumer behavior.read more of gilt substitute purchases.

Second, CE is more successful in reducing credit spreadsCredit SpreadsCredit Spread is the yield gap between similar bonds but with different credit quality. If a 5-year Treasury bond yields 5% and a 5-year Corporate Bond yields 6.5 percent, the gap over Treasury is 150 basis points (1.5 percent ).read more, with this benefit becoming larger with time and only being significant for higher-rated bonds. Third, unlike QE, CE can encourage corporate issuance very quickly. In a low-interest-rate environment, CE could be a useful monetary policyMonetary PolicyMonetary policy refers to the steps taken by a country’s central bank to control the money supply for economic stability. For example, policymakers manipulate money circulation for increasing employment, GDP, price stability by using tools such as interest rates, reserves, bonds, etc.read more instrument. The relative efficacy of CE and QE may be influenced by the quality/risk of private bonds. It is linked to the amount of risk a central bank is willing to take on in adding to its balance sheet.

This has been a guide to What is Credit Easing & its Definition. We discuss credit easing examples , explanations and differences with quantitative easing.. You can learn more from the following articles –

The government buys securities such as bonds from the market to make credit or liquidity available in the market. As a result, it increases the amount of money available in the market and influences the money supply. This leads to the encouragement of lending and investment.

Federal credit easing is a monetary policy adopted by central banks to ease credit into the economy. It purchases assets to make liquidity available in times of financial stress. This saves the economy from zero bound lower rates and boosts economic growth.

The economy benefits from credit easing policies, starting with the financial institutions. They will have more money to lend; businesses can borrow money; investments grow, and jobs are created. In addition, people will have money to spend, stabilizing the money supply.

  • Credit DerivativesCredit ReferenceTariff