The decision to inject £75bn into the economy (could be upto £150bn or 10% of economy) is a radical step for the Bank of England and the economy. The decision to pursue quantitative easing has been taken because of:
- The extent of the economic downturn
- The fact lower interest rates have not helped the economy recover
- The fact interest rates cannot effectively be cut further (0.5% today)
- The fact inflation is predicted to fall below target of 2% risking prospect of deflation.
What is Quantitative Easing?
- The Central bank undertakes to buy various assets - commercial and government bonds from banks. To buy these bonds the Central Bank issues Central Bank reserves. This is effectively creating money through electronic means
- Banks gain an increase in liquidity because they sell assets for cash. This increase in banks balance sheets should hopefully encourage them to lend more.
- By buying assets and government bonds. The price of bonds rises causing interest rates on bonds to fall. These lower rates should help boost spending
- Bank of England £75bn Asset purchase scheme at B of E website
Possible Problems of Quantitative Easing
- Inflation. When economy recovers it might be difficult to take out the excess money supply causing uncontrollable inflation.
- Investors could lose confidence in economy due to risk of inflation
- Danger of 'bond bubble'. Bonds and gilts will rise in price encouraging investors to buy and interest rates to fall. This could cause a bubble in the price of gilts which could collapse at a later stage causing long term interest rates to rise at an early stage in the business cycle.
- Could cause lower value of Pound - Pound slumps on QE fears