Quantitative Easing vs. Currency Manipulation

In the wake of the 2008-2009 Great Recession, central banks around the world entered unchartered territory when they began quantitative easing - the purchasing long-term securities such as Treasuries and mortgage-backed securities. By pumping money into the financial system, central banks staved off a complete collapse of the banking system, and the flood of cash lowered interest rates in the hope growth would return.

In 2009, the U.S. Federal Reserve was the first central bank to begin purchasing securities. As interest rates fell, so did the U.S. dollar. In the month proceeding the announcement of QE1, the U.S. dollar index (DXY) fell 10 percent - its biggest monthly fall in over a decade. Given this, how do QE and currency manipulation differ, how are they similar, and why do central banks engage in the practices?

As it turns out, currency manipulation is not that easy to identify. As one Wall Street Journal blog post puts it, “Currency manipulation is not like pornography—you don’t know it when you think you see it.” Policy action that favorably affects a country's exchange rate—making exports more competitive—is not in itself evidence of currency manipulation. You also have to prove that the value of the currency is being held artificially below its true value. What’s the true value of a currency? That’s not easy to determine either.

In general, countries prefer their currency to be weak because it makes them more competitive on the international trade front. A lower currency makes a countries exports more attractive because they are cheaper on the international market. For example, a weak U.S. dollar makes U.S. car exports less expensive for offshore buyers. Secondly, by boosting exports, a country can use a lower currency to shrink its trade deficit. Finally, a weaker currency alleviates pressure on a countries sovereign debt obligations. After issuing offshore debt, a country will make payments, and as these payments are denominated in the offshore currency, a weak local currency effectively decreases these debt payments. 

Countries around the world adopt different practices to keep the value of its currency low. The rate on the Chinese yuan is set each morning by the People's Bank of China (PBOC). The central bank does not allow its currency to trade outside of a set band over the next 24-hours, which prevents it from any significant intraday declines. 

A more direct form of currency manipulation is intervention. After the appreciation of the Swiss franc during the financial crisis, the Swiss National Bank purchased up large sums of foreign currency, namely USD and euro's, and sold the franc. By moving its currency lower through direct market intervention, it hoped Switzerland would increase its trade position within Europe. 

Finally, some pundits have argued that another form of currency manipulation is quantitative easing.  

Quantitative easing, while considered an unconventional monetary policy, is just an extension of the usual business of open market operations. Open market operations is the mechanism by which a central bank either expands or contracts the money supply through the buying or selling of government securities in the open market. The goal is to reach a specified target for short-term interest rates that will have an effect on all other interest rates within the economy.

Quantitative easing is meant to stimulate a sluggish economy when normal expansionary open market operations have failed. With an economy in recession and interest rates at the zero-bound, the Federal Reserve conducted three rounds of quantitative easing, adding more than $3.5 trillion to its balance sheet by October 2014. Intended to stimulate the domestic economy, these stimulus measures had indirect effects on the exchange rate, putting downward pressure on the dollar.

Such pressure on the dollar wasn't entirely negative in the eyes of U.S. policymakers since it would make exports relatively cheaper, which is another way to help stimulate the economy. However, the move came with criticisms from policymakers in other countries complaining that a weakened U.S. dollar was hurting their exports. Economists then began the debate: Is QE a form of currency manipulation. 

While the Federal Reserve was intentionally engaging in a monetary policy action that decreased the value of its currency, the intended effect was to lower domestic interest rates to encourage greater borrowing and, ultimately, more spending. The indirect impact of a deterioration of the exchange rate is just the consequence of having a flexible exchange-rate regime. (See also Does Quantitative Easing Work?)

In theory, currency manipulation and a monetary policy like quantitative easing aren't the same thing. One is interest rate policy based and the other currency focused. However, as central banks began their QE programs, one result was the weakening of its currency.

Intentional or not, it can be argued that QE is, in some way, a form of currency engineering. Whether its manipulation that will always be up for debate.