Is quantitative easing advisable?

February 22, 2012
Tom Witherow

In March 2009 the Bank of England, in a bid to boost economic growth, adopted a seldom used tool of monetary policy, known as quantitative easing. The Bank had already cut interest rates to 0.5 per cent – a record low – and so, in order to further stimulate the economy, began to buy government debt with cash it created. The Bank ended up purchasing £200bn of debt over the next ten months, before pumping a further £75bn into the economy in October 2011.

On February 9th, the Bank of England announced an additional £50 billion would be spent in the battle to keep Britain from a double -dip recession. How does quantitative easing work? The Bank buys up government debt from various types of institutions – pension funds, non-financial firms and banks – with money it creates. This decreases the yields on such debt, which encourages these institutions to instead invest in corporate debt and equity.

This lowers corporate borrowing costs because there is greater demand for their debt – they do not have to offer such high returns to encourage people to invest. Lower borrowing costs encourage firms to expand, increasing investment in the economy. Moreover, share-owning consumers will feel more confident as the equity they hold is more greatly demanded.

These are the theoretical benefits. However the government is pulling the wool over our eyes by pursuing this policy – and using an institution that is meant to be wholly independent to do so.

Quantitative easing is essentially the printing of bank notes – think a controlled version of Weimar Germany, or Mugabe’s Zimbabwe. But the presses aren’t actually rolling as the money created are digital deposits in BoE accounts.

As well as allowing companies to borrow more cheaply, QE allows the government to do so – if there is demand for its debt then it does not have to offer such good rates of return, or interest, to potential investors. Convenient. Secondly, because there is more money in the economy, but the same amount of wealth, the number of pounds you need to buy goods increases. Inflation.

But isn’t £50 billion peanuts compared to the £275 billion created in the last two and a bit years? Well, when first implemented Britain faced depression and deflation – when prices fall uncontrollably, driving up the value of debt. Things are different now – we’re not facing depression and inflation is threatening. Also Citi analysts, amongst others, forecast this is the first burst in a £325 billion push.

Now the crux. Quantitative easing is unfair. And yet in a world of bonus-bashing and benefit-swindler-hating there is surprisingly little to be said of this decision. Debtors caused the recession, but now savers are paying. Increasing the amount of money in the economy decreases interest rates on our savings. Think of your student loan – we have to pay it back at the rate of inflation, five per cent now. 15 per cent tomorrow?
Tucked away in the small print of a BoE report was the admission that so far QE has led to a rise in inflation of between one and 2.6 per cent. Compare that to the public response to the 2.5 per cent increase in VAT. Inflation could spiral; Taleb thinks there is a 10 per cent chance of this. That is a significant risk.

The banks are flooded with liquidity – good news for bonuses. And their mighty stack of assets gives them something to borrow against at the lowered rate of interest. Asset prices rise – marvellous for the rich – while the average man on the street cannot get a mortgage for the house he wants.

And remember, this is not even the government’s policy. It is the supposedly independent Bank that is implementing this. It is easing political pressure on Cameron, by keeping the recession at bay in the short term, while contravening its only mandate: to keep inflation between one and three per cent. But apparently we’re not that fussed about that. It has only achieved this target in nine of the last 68 months.

Of course, Cameron is keeping shtum about this. It buys him time. One could argue that QE is all that is keeping the economy afloat, but it is a short-term fix. Both economically, as stagflation threatens, and politically, as voters wake up to the glaring inequality inherent to an increase in the money supply.

“Possibly the biggest gamble in British economic history,” one commentator said this week. Perhaps a little strong, but it is certainly a policy which needs to be questioned – the current apathy does not reflect QE’s significance and far-reaching consequences.

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