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Quantitative Easing Explained
Last week The Bank of England made the decision to boost its Quantitative Easing (QE) programme, unleashing £75 billion of emergency support in a bid to boost bank lending and aid the UK’s recovery. This meant that the Bank has decided to hold interest rates at 0.5% and have increased their Quantitative Easing policy from an initial £200 billion to £275 billion. This is the clearest signal yet that the Bank believes Britain is indeed on the brink of a double-dip recession.
But, what exactly is Quantitative Easing?
Quantitative Easing is an emergency measure used to boost economic growth by increasing the supply of money. This is something the Bank of England would usually try to achieve by slashing interest rates, but when rates cannot go any lower, the Bank will pump cash directly into the economy to encourage lending and activity. In our current situation, with interest rates now so low, central banks can no longer hope to revive ailing economies by cutting the price of money and making it cheaper for people to borrow, they have run out of ammunition. Instead, they can choose to inject more money directly into the economy. The Bank of England will buy £75 billion worth of government bonds, known as ‘gilts’ currently held by the banks. The sellers of these assets can then use the extra funds the Bank gives them, to spend on other investments, or lend to households or businesses. Buying billions of pounds of gilts should also drive up bond prices, and reduce yields (the rate investors receive for lending the government money). Since many other interest rates are priced according to government bond yields, this should also help to cut interest rates across the economy.
Will Quantitative Easing work?
As with most things in economics, opinion is sharply divided. The Positive and Negative points have been summarised below:
• It provides additional cash in the system when there is a shortage.
• It doesn't cost the government or taxpayer anything.
• The situation now could have been significantly worse without previous rounds.
• It could boost confidence in the system.
• If you rule out fiscal policy, as the coalition has done, then it is one of the only options left.
• There's no real clear evidence as to what happens to the money once the money is released
• The risk is that the money keeps piling up in the banks’ balance sheet and never helps small businesses where it's needed.
• It's too late to use QE as another confidence trick, it might just look desperate.
• A minority of economists, such as the former MPC committee member Andrew Sentance, believe it could feed inflation.
What do I think?
I have been talking about Quantitative Easing for the past couple of weeks in my tweets, blogs and podcasts. It was inevitable that this was going to happen as it was clear that the economy needed further stimulus. As Mervyn King says: “We’re creating money because there’s not enough money in the economy. That may seem unfamiliar to people, but that’s because this is the most serious financial crisis at least since the 1930s, if not ever,”
There is no certainty that Quantitative Easing will work, but we don’t have much to lose when there aren't a lot of other options. All we can do now is wait and hope that this aides our economic recovery.
Chartered Financial Planner