Since the global financial crisis, both the Bank of England and the Federal Reserve have used the policy of quantitative easing (QE) to try to revive consumer spending and economic growth.
In the UK, the Bank of England began its “asset purchases” in January 2009.
The Bank has so far committed a total of £375bn to QE, while in September the Fed said it would spend a further $40bn (£25bn) per month. This was on top of the $2.3tn the Fed had already put into QE since 2008.
At the Bank’s meeting in early February, governor Sir Mervyn King backed more action to boost the amount of QE purchases above £375bn but was outvoted by his colleagues.
What is quantitative easing?
Usually, central banks try to raise the amount of lending and activity in the economy indirectly, by cutting interest rates.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower, a central bank’s only option is to pump money into the economy directly. That is quantitative easing (QE).
The way the central bank does this is by buying assets – usually government bonds – using money it has simply created out of thin air.
The institutions selling those bonds (either commercial banks or other financial businesses such as insurance companies) will then have “new” money in their accounts, which then boosts the money supply.
It was tried first by a central bank in Japan to get it out of a period of deflation following its asset bubble collapse in the 1990s.
Prior to 2009, QE had never been tried before in the UK.
Is this printing money?
These days the Bank of England does not have to literally print money – it is all done electronically.
However, economists still argue that QE is the same principle as printing money as it is a deliberate expansion of the central bank’s balance sheet and the monetary base.
How does it work?
Under QE a central bank purchases government bonds from private sector companies or institutions, typically insurance companies, pension funds and High Street banks.
This increased demand for the government bonds pushes up their value, thereby making them more expensive to buy, and so they become a less attractive investment.
This means that the companies who sold the bonds may use the proceeds to invest in other companies or lend to individuals, rather than buying any more of the bonds.
The hope is that with banks, pension funds and insurance firms now more enthusiastic about lending to companies and individuals, the interest rates they charge fall, so more money is spent and the economy is boosted.
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