Over the past decades, concerns regarding deflation have spiked after big financial crises. One good example is Japan. After Japan’s equities, as well as real estate bubbles, burst in 1989-90, forcing the Nikkei index to lose one-third of its value in a short time span, deflation became entrenched.
The country’s economy, which had been one of the fastest-growing in the world from the 1960s to the 1980s, slowed considerably. Unfortunately, the ’90s became known as Japan’s Lost Decade.
It is worth mentioning that the Great Recession of 2008-09 triggered fears of a similar period of prolonged deflation in the United States as well as other parts of the world due to the collapse in prices of a wide range of assets.
Let’s not forget that the global financial system was also thrown into turmoil by the insolvency of several major banks as well as financial institutions throughout the United States and Europe.
It is a good idea to take a look at the pin bar candlestick.
Federal Reserve and deflation
In response, in the last month of 2008, the Federal Open Market Committee turned to two main types of unorthodox monetary policy tools: (1) forward policy guidance as well as (2) large-scale asset purchases, aka quantitative easing (QE).
The first tool involved reducing the target federal funds rate essentially to zero and keeping it there at least through mid-2013.
What’s interesting, quantitative easing attracted attention and became synonymous with the central bank’s easy-money policies. Quantitative easing (QE) basically involves a central bank creating new money and using it in order to buy securities from the country’s banks so as to pump liquidity into the economy and drive down long-term interest rates.
In the above-mentioned case, it allowed the Federal Reserve to purchase riskier assets, including mortgage-backed securities and other non-government debt.
What’s important, this ripples through to other interest rates across the economy as well as the broad decline in interest rates stimulates demand for loans from consumers as well as businesses. Importantly, banks are able to meet this higher demand for loans thanks to the funds banks have received from the country’s central bank in exchange for their securities holdings.
European Central Bank and deflation
Several years ago, more precisely, in January 2015, the European Central Bank (ECB) embarked on its own version of quantitative easing by promising to purchase at least 1.1 trillion euros’ worth of bonds.
It launched its QE program in order to support the fragile recovery in Europe and fend off deflation after its historic move to reduce the benchmark lending rate below 0% in late 2014, met with only limited success.
While the European Central Bank was the first major central bank to experiment with negative interest rates, several central banks in Europe, including those of Sweden and Switzerland, have pushed their benchmark interest rates below the zero bound.
As you can see from the information mentioned above, the Federal Reserve and other central banks have to deal with various challenges on a regular basis.