Quantitative Easing (QE), Changes in Global Liquidity, and Financial Instability

Abstract

This article argues that quantitative easing (QE) led to significant changes in the global financial system that are not conducive to greater financial stability. Through a policy of reserve accumulation, QE did not have a direct impact in the creation of global liquidity through bank lending. It rather reinforced the statistical decoupling between base money and the money supply and between deposits and loans. However, QE did have an effect on the composition of global liquidity by altering the relative profitability of investing in different assets and in this way exerted a positive effect on the performance of the international bond market, to which the decline in bank credit due to the deleveraging of global banks in the aftermath of the crisis contributed. The growing role of the international bond market facilitated the expansion of the debt of both the financial sector and the nonfinancial corporate sector in developing economies but also has reinforced the role of the asset management industry in financial markets. Due to its concentration and interconnectedness, illiquidity, and procyclicality, the asset management industry poses important risks to financial stability.