Quantitative Easing Explained

In an effort to prevent the economy slipping into depression, the Bank of England has slashed interest rates to 0.5%. But with rates at rock bottom the Bank - which acts on behalf of the Government - has left itself with little room to manoeuvre. Subsequently, it's embarked on a more controversial stimulus programme, known as Quantitative Easing.

This oblique term sounds technical, but it's little more than a euphemism for good old-fashioned money printing. It all boils down to increasing the supply of money in the economy, as the Bank of England explains on its website:

"Instead of lowering Bank Rate to increase the amount of money in the economy, the Bank supplies extra money directly. This does not involve printing more banknotes. Instead the Bank pays for these assets by creating money electronically and crediting the accounts of the companies it bought the assets from. This extra money supports more spending in the economy to bring future inflation back to the target."

Printing money

Apparently because we now print money electronically, everything's going to be hunky dory. Really? The Bank insists QE is necessary to maintain inflation at the target rate of 2%. Although this may or may not be true, it's important to understand QE's other role: namely funding public spending by creating money from thin air.

Quantitative Easing involves the Bank of England creating money to buy back UK gilts. In doing so it's funding a glut of borrowing that the Government knows it would struggle to raise on the bond market. If you were a foreign investor in British bonds, what would you think about being paid with devalued money? This is one of the main reasons sterling has declined by 30% against the Dollar in recent years. We're not the world's reserve currency so we can't get away with tricks like this.

Between March and July 2009 the Bank of England literally created £113.8 billion of new money to buy gilts. In the same period the DMO sold £80 billion of debt in its auctions. So we're currently printing money at a faster rate than we're legitimately selling bonds to investors. The question is, does a government hooked on spending know when to stop?

Debauching our currency to relieve the debt burden is only going to create an even bigger crisis of confidence. If investors pull the plug on our spending habit, the Pound will decline even further and everything we import will get more expensive. Interest rates will climb higher, as the bond market demands a higher return to risk money on Britain. This all adds up to a truly toxic combination for our fragile economy.

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