Semantron 2015

Quantitative Easing

Christopher Stone

Quantitative Easing, QE, is one of the newest and most untested concepts in modern day economics, yet it has played an important part in stimulating growth in the recovering economies of the UK, USA and Japan. In 2009 the UK undertook quantitative easing and since then it has grown the Bank of England’s balance sheet to £375billion 1 worth of assets, so by no means is this as simple as raising and lowering interest rates and its impacts are near on impossible to judge. Despite this the question still remains and all eyes are on the Monetary Policy Committee, MPC, as to when and how do they begin to sell the asset purchases before to increased money supply effects inflation without damaging the fragile UK recovery. Before I begin the trying to decipher whether there has been a positive outcome from QE I should give a brief overview of how it works. The Monetary Policy Committee at the Bank of England monthly will agree on a figure, to create electronically to spend on asset purchases. The money once created is used to buy up UK Government Bonds and other qualifying assets causing the price of these assets to rise and therefore the yield of such investments will begin to fall alongside interest rates. As the yields fall private investors begin to look elsewhere to invest e.g. equities, corporate bonds or loans, which promise a higher potential yield. The idea behind this is that investment increases and the suppressed interest rates, encourage borrowing leading to a further increase in borrowing by businesses and households alike. Once the economy is either back on track or inflationary pressures are forcing CPI inflation above the 2% target the bank will begin to sell of its purchased assets, N.B. this will be after the base rate of interest has been raised but we will look at this in more depth later, until either its targets are met or until it no longer holds any of the assets that it purchased. This will increase the yields of bonds again and cause the cost of borrowing to rise causing inflation to fall and growth to slow back to a sustainable level. For now, however, let’s go back to the start of the process in 2009 when the UK economy was in recession with growth as low as -2%. As the Bank of England cut interest rates to a record low of 0.5%, a level which it hasn’t moved from for over 5 years, the Monetary Policy committee decided to take further action. This came in the form of QE and it began with a first round of £200bn to buy government bonds to reduce yields and force down interest rates. From 2009 to the end of 2011 bond yields fell from 4% to 1.9% on 10-year gilts 2 . Although bond yields were already falling it does suggest that the decision to start QE did have an effect as the speed at which yields were falling increased. This increased money supply that forced long term interest rates, some economists believe, had a vital impact on the economy as it potentially has helped the UK economy to avoid the deflationary pressures that would have caused the cost of debt to rise causing major damage to economy. 3 This scenario isn’t too far off what is being experienced in the Eurozone, with inflation below 1% the possibility of deflation could be disastrous given the high levels of debt. The IMF has claimed that QE will have huge benefits including increased supply and demand for credit producing a direct stimulus to the Eurozone economy in the form of consumer spending and investment, which provides an ‘overwhelming case’ for QE in Europe. 4 However, has it had the same effect on the UK economy? Although many economists have claimed QE to be necessary there are split views as to its success in 2012, the Bank of England claimed that QE had increased GDP by 1.5-2% with the first £200bn of quantitative easing. However, after this claim was made the UK slipped into a double dip recession suggesting one of two things, either QE wasn’t working or it was taking longer to stimulate the

1 http://www.bankofengland.co.uk/monetarypolicy/Pages/qe/default.aspx 2 The journey towards becoming Japan. 3 The case for truly bold monetary policy 4 Eurozone needs quantitative easing

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