A (1) Motive/reasons for quantitative Easing

Quantitative Easing may have been intended to be kind of insurance policy[ CITATION Ell09 \l 1033 ]
if foreign central bank of U.S bonds collapsed, the Fed would already have a program in place to buy
them back itself.

It is said that quantitative easing was meant to create EU jobs. Even a hard core proponent of QE, Fed
official William Dudley ( formerly of Goldman Sachs), admitted that the Fed’s own economic models
could explain how creating money out of thin air and using it to buy U.S. bonds would increase
employment. Some link to rising stock prices could be demonstrated, if only through the cheap
financing of corporate stock buy-backs, but then rising stock prices could be shown to create jobs
either.

Studies by [ CITATION Jur10 \l 1033 ] suggested that it did raise economic activity a bit. But some
worry that the flood of cash has encouraged reckless financial behaviour and directed a fire hose of
money to emerging economies that cannot manage the cash. Others fear that when central banks sell
the assets they have accumulated, interest rates will soar, choking off the recovery

The idea is that by making it easier to obtain loans, interest rates will drop and consumers and
businesses will borrow and spend. Theoretically, the increased spending result in increased
consumption, which increases the demand for goods and services, fosters job creation and, ultimately,
creates economic vitality.

The drawback of quantitative easing

 The new inflow of money into commercial banks from quantitative easing has encouraged
banks to use this extra money through greater risk taking. Some argue that Q.E. has increased
the risk taking nature of banks (a problem behind 2008 crisis[ CITATION Ben11 \l 1033 ])
 Bond traders have benefited from making large profits out of the Bank of England by
manipulating the bond market.
 Because government debt is being financed by quantitative easing, the government has less
market discipline to think about reducing fiscal deficits and tackle the underlying problem
of UK public sector debts rising to 100% of GDP by 2016.
 Quantitative easing has been a stealth method of reducing the value of the Pound and Dollar –
and therefore making UK exports cheaper. Some commentators call this Currency
Manipulation  (or Currency war). They argue this is unfair on emerging markets that are
seeing their exports become less competitive[ CITATION Mac05 \l 1033 ].
 The increase in money supply has led to an unexpected rise in commodity prices, such as oil.
This is unusual when the Western economies are in recession; rising oil prices has led to cost-
push inflation.
 By depressing interest rates, quantitative easing has wiped out people’s return on savings
(though share price rises have compensated to a certain extent.)
 Quantitative easing is causing inflation in the UK. (Inflation has frequently been above the
government’s target of 2%, and when the velocity of circulation rises, these extra bank
balances will be lent – causing a possible inflationary surge.
  The scale of quantitative easing could make it impossible to sell bonds back to market and
this will damage the UK’s ability to borrow in the future. If the UK’s ability to borrow is
constrained, this will lead to higher interest rates and reduce economic growth.
 Evidence in US, suggests even raising the possibility of tapping could cause damage to the
bond market, and higher interest rates. These higher interest rates could reduce economic
growth.

Advantages of Quantitative Easing

 Low bank lending. There is no real evidence that there has been a surge in risky bank
lending. In fact the opposite has been the main concern over the past few years. – A more
potent criticism of Q.E. is perhaps that it did so little to increase commercial bank lending.
Bank lending is still very low compared to pre-crisis trends.
 We need fiscal expansion not austerity. It is a very good thing if Quantitative easing has
reduced the need for austerity and immediate measures to cut budget deficits. If the UK has
pursued Greek or Spanish style austerity, the UK recovery would have been much weaker or
non-existent. A recession is not the time to tackle the public sector debt. The important thing
is to promote economic growth; this will enable debt to be tackled in the long term, when the
economy can better absorb spending cuts and tax rises.
 No currency manipulation. It is hard to accuse the UK of currency manipulation when we
have a current account deficit of nearly 3% of GDP. The current account suggests the UK is
still uncompetitive. Given the fact the UK GDP is still lower than in 2008, it is the correct
thing for the monetary authorities to try and pursue monetary policy which promotes
economic recovery and higher employment. It is not currency manipulation when you are
pursuing a reasonable monetary policy given the state of the economy and lost
GDP[ CITATION Kin11 \l 1033 ].
 Inflation has not been a macro-economic problem since 2008. The main macro-problem
has been significant fall in GDP and unemployment. The Bank of England are correct to
concentrate on these real problems. True, inflation has been a little above target, contributing
to a reduction in real wages. But, the inflation is due to cost-push factors like rising oil prices
and the effects of depreciation. There is no sign of an inflationary surge. The programme
blames Q.E. for the fall in real wages. But, I believe this is wrong, the fall in real wages is
because of the recession and collapse in wage growth. The best way to promote real wage
growth is to target economic recovery. It is economic recovery which will enable real wage
growth and higher living standards. I don’t accept that Q.E. is the major factor behind falling
real wages. Real wages would definitely have fallen without Q.E.
 Europe inflation still too low. Inflation in the ECB is 0.8% – that is still low and creates the
risk of deflationary pressures. This suggests the ECB have done too little money creation and
have pursued too tight monetary policy. Unemployment in the Eurozone is 12%, significantly
higher than the UK. UK unemployment may well be higher, if we hadn’t pursued quantitative
easing.
  Future inflationary surge? It is true that if the velocity of circulation rises, there could be
inflationary pressure. But, given the level of unemployment and spare capacity in the
economy, the inflationary surge is hard to see. It hasn’t materialized in past 5 year Blue line is
monetary base (one form of money supply). This surge in monetary base has had no effect on
inflation.
 Also, as Adam Posen says, it is possible for the Bank of England to deal with inflation, should
it reappear. It is more difficult to deal with stagnant economy

Conclusion
Overall, monetary policy is constantly in a state of flux, but still relies on the basic concept of
manipulating interest rates and, therefore, money supply, economic activity and inflation. It is
important to understand why the Fed institutes certain policies and how those policies could
potentially play out in the economy. This is because the ebbs and flows of economic cycles offer
opportunity by creating profitable times to either embrace or avoid investment risk. As such,
having a sound understanding of monetary policy is key to identifying good opportunities in the
markets.
Furthermore, Quantitative easing is an untried and imperfect policy. The programme makes good
points about how traders benefited unfairly, and also it is a significant point that Q.E. has created
a strong political and economic pressure group to maintain Q.E. out of selfish motives. It is also
very uncertain what will happen as the economy returns to normal and the Central Banks try to
taper and end Q.E. But, though it is imperfect and there is risk of different problems – given the
uniquely dire state of the economy in the past few years, I still feel Q.E. was better than the
alternative – that alternative was accepting a deeper and more prolonged recession .

B (1) Solution
We can model this situation by the following two-player strategic game.

Minister of Finance

Contractionary Policy Expansionary

Central Banker (C) Policy (E)
Contractionary 3, 2 0, 0
Policy (C)
Expansionary Policy 0,0 2, 3
(E)

To find the Nash equilibria, we examine each action profile in turn.

(C, C)
Neither player can increase her payoff by choosing an action different from her current one.
Thus this action profile is a Nash equilibrium.
(E, C)
By choosing C rather than E, Central Banker obtains a payoff of 2 rather than 0, given a
Minister's action. Thus this action profile is not a Nash equilibrium. (Also, Minister can
increase her payoff by choosing C rather than E.)
(E, C)
By choosing C rather than E, Central Banker obtains a payoff of 3 rather than
0, given Minister's action. Thus this action profile is not a Nash equilibrium. [Also, Minister
can increase her payoff by choosing E rather than C.]
(E,E)
Neither player can increase her payoff by choosing an action different from her current one.
Thus this action profile is a Nash equilibrium.

In additions If they disagree and choose different distributions, they are likely to receive 0 payoffs.

Therefore, there the game has two Nash Equilibria,(C,C),and (E,E)

Where by, C=Contractionary Policy
E=Expansionary Policy

B (2) In case the disagreement is detrimental the Bargaining salutations should be used;
Various solutions have been proposed based on slightly different assumptions about what properties
are desired for the final agreement point.[ CITATION Kal97 \l 1033 ]

Nash proposed that a solution should satisfy certain axioms:

1. Invariant to affine transformations or Invariant to equivalent utility representations
2. Pareto optimality
3. Independence of irrelevant alternatives
4. Symmetry

Let u and v be the utility functions of Central Banker and Minister of Finance, respectively. In the
Nash bargaining solution, the players will seek to maximize, (u(x)-u(d) *v(y)-v(d)) where u(d) and
v(d) and , are the status quo utilities (i.e. the utility obtained if one decides not to bargain with the
other player). The product of the two excess utilities is generally referred to as the Nash product.
Intuitively, the solution consists of each player getting her status quo payoff (i.e., no cooperative
payoff) in addition to an equal share of the benefits accruing from cooperation

Other solutions includes

 Kalai Smorodinsky bargaining solution
  Egalitarian bargaining solution

Bibliography
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Elliot, & Larry. (2009, January 08). Gurdian business Grossary;Quantitative easing. London, UK.

Jury, A. (2010). Is quantitative Easing raising Europe Economy? European Journal Of Econometry,
35-37.

Kalai, & Ehud. (1997). Proportional solutions to bargaining situations: Intertemporal utility
comparisons.

King, & Mervyn. (2011). No Guarantee bankinh lending will raise. LONDON: BBC.

Lussevel, M. (2005). Euro Economy money supply. London: BP.