On 11th March 2009 the Bank of England started a policy of quantitative easing. QE is also called an ‘asset purchase scheme’. It was extended to a total of £275 billion in October 2011 and is likely to be expanded further during 2012.
Other central banks have introduced quantitative easing in recent year through huge purchases of government bonds. Indeed the economist Gavyn Davies, writing recently in the Financial Times has calculated that “around one half of the bonds issued to fund the budget deficits of the US, UK and eurozone since 2008 have been acquired by the Fed, BoE and ECB.”
This is a remarkable change in the conduct of monetary policy in advanced nations.
The aim of QE is to inject liquidity into the banking system, boost demand and prevent inflation remaining persistently below target or becoming negative (deflation).
The Bank moved to QE because nominal interest rates had already been cut close to zero and because it was felt that low interest rates were having little effect on aggregate demand in other words a liquidity trap was being experienced.
The conventional use of Monetary Policy appeared to have lost traction because of the circumstances of the global financial crisis.
The Bank of England uses quantitative easing to act on the quantity of money. The media call this ‘printing money’ but this is only true in an electronic sense – the Bank does not print new £10, £20 and £50 notes in a direct attempt to inject cash into the economy!
QE is a deliberate expansion of the central bank’s balance sheet and the economy’s monetary base.
1/ A rising demand for bonds and other assets ought to drive up their price and lead to a fall in long-term interest rates (yields) on such assets. (There is an inverse relationship between bond prices and bond yields).
2/ If long-term interest rates fall and the banks have stronger balance sheets because of BoE purchases, the hope is that this will stimulate lending and stronger growth of business and consumer demand
Has QE worked?
1. Cash hoarding: Asset purchases have improved the liquidity of banks and pension funds but banks have been happy to ‘sit on the cash’ rather than lending to businesses and consumers.
2. Credit availability remains low – many businesses who need funds to expand complain that they remain effectively frozen out of the loans market or have to pay premium interest rates
3. De-leveraging: Commercial banks are still engaged in a process of de-leveraging meaning they are desperate to reduce the amount of existing debt before starting to lend out again. They are risk-averse or cautious about expanding their lending
4. Opportunity cost: Is £275bn of QE the best use of the Bank of England’s money? How much of it has filtered through to the small businesses likely to lead the way in creating new jobs in the next few years?
5. Future inflation: Monetarist economists warn that a huge expansion of the money supply through quantitative easing risks causing much higher inflation in the years ahead.
QE in other countries
QE has been tried in other countries including the United States. And it became an important part of the policy of the Bank of Japan to drag their economy out of a deflationary slump in the 1990s.
The European Central Bank (ECB) has been more reluctant to use QE during the present slump but started to do so during the summer and autumn of 2011
Channel 4 News: Bank of England Governor Mervyn King talks to Channel 4 News’ Economics Editor Faisal Islam about the pros and cons of QE.
AlJazeera: Skepticism clouds new US stimulus plan (US QE)
One revision to the current system of QE is that the Bank of England should buy newly issued bonds directly from the government rather than existing bonds held by the commercial banking system. What is the reasoning?
• The early version of quantitative easing has done little to boost lending by the Banks
• The UK government is solvent, there is a negligible risk of default for the Bank of England
• It would allow the government to cut taxes temporarily to boost demand and kick start the economy using fiscal policy whilst holding down spending as planned in the 2010 review
• Effectively the BoE becomes bond purchaser of first resort, the central bank would be financing fiscal policy decisions, monetary and fiscal policy would become joined at the hip.
Is there an alternative?
1. Credit easing: Another policy proposed is called credit easing where the Bank of England buys the bonds issued by companies to help them finance a rise in capital investment.In his November 2011 Autumn Statement, Chancellor George Osborne announced a £40bn “credit easing” scheme to make it simpler to underwrite bank loans to small firms.
2. Bank bonds: Some economists are now calling for the Bank of England to buy bonds issued by commercial banks so that the banks can build up their capital base and eventually lend out more to hard-pressed businesses and consumers.
This resource comprises a complete collection of editable lesson topic worksheets and exam-style case studies that are ideal for teaching individual topics for the whole Year 1 (AS) teaching content.