Knowledge

What on earth is Quantitative Easing?

Posted on Sep 8th, 2016 | News and opinion

In August 2016, the Bank of England announced another imminent bout of Quantitative Easing as a result of economic unrest following the Brexit vote.

Now, Quantitative Easing is a hard enough term to spell or pronounce, let alone decipher without sounding like you’re trying to explain complex brain surgery, or what happened at the end of ‘LOST’.

Nonetheless, here’s a short walkthrough, broken down with as little technical jargon as possible.

Go on then, what is Quantitative Easing?

The Bank of England, our central bank, is responsible for keeping the country’s economy afloat.

When the country isn’t producing enough goods or services, this is referred to as a lack of economic growth. Sometimes when this happens, the Bank of England’s Monetary Policy Committee decides to lower the interest rate it charges banks to borrow money from them.

This in turn means banks can afford to reduce their interest rates too, making it cheaper for people and businesses to get loans. Usually, this would lead to more spending, more job creation and therefore more taxation, giving the economy a boost.

Of course, that’s all well and good, but when base interest rates are already at almost zero (they recently dropped to 0.25%), banks can’t afford to reduce them any lower. If they did, they’d be giving money out without providing an incentive for speedy repayment.

So instead, more money is electronically (not literally) ‘printed’ out of thin air and used to buy assets such as packaged-up government debt from banks. Presenting the banks with this extra money encourages them to be more relaxed about lending it out, and makes us more relaxed about spending it. This process is called Quantitative Easing, or QE for short.

When the economy has recovered, to avoid diluting the value of the pound, the Bank of England sells on the assets it purchased. The cash it received from the sales is then sterilised, meaning no extra money is left in the system.

Does it actually work?

This method of stimulating the economy was previously utilised during the economic crisis of 2007-09, with the Bank of England using newly created money to buy £375bn worth of assets from banks and other financial institutions. It is claimed that without quantitative easing, the recession would have been even deeper.

The act of creating more money comes under a lot of criticism due to the danger of diluting the value of currency. Whilst in opposition in 2009, George Osborne called QE “the last resort of desperate governments,” telling the BBC, “It is an admission of failure and carries considerable risk.”

Advocates of QE argue though that high levels of inflation can be avoided if the strategy is pursued responsibly, and interestingly, Osborne later agreed to the printing of a further £75bn as Chancellor in 2011.

On the other hand, according to Positive Money, the experiment was a colossal failure that resulted in the richest 5% of the population becoming richer by £128,000 per household, with just 8p for every pound created trickling down into the ‘real economy’ (i.e. the production of goods and services, as opposed to the money moving around in the financial markets).

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Written by Tom West

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