Has QE been successful?

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Andrew Robertson,Head of Economics and Business Studies, Alleyn’s School

Quantitative easing (QE) is the injection of money into the economy by the country’s central bank.

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The Bank of England creates money electronically by changing the amount in its account.

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The Bank then buys financial assets from commercial banks.

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What is QE?

Since the start of QE in March 2009 the Bank has added £375bn to its balance.

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This has been spent primarily on buying government bonds (gilts), but a small proportion has been spent on buying corporate bonds to make money available to companies.

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The Monetary Policy Committee’s (MPC) main tool is to lower/raise interest rates to encourage/discourage borrowing.

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The main macro effect is on the circular flow of income and therefore Aggregate Demand (AD), primarily through affecting consumption but also investment.

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Recognising the global downturn in 2008 the MPC cut interest rates from 5% to 0.5% from November 2008 to March 2009, the lowest level in its history.

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QE: Why, when andhow much (1)?

The MPC now faced a liquidity trap where cuts in interest rates were becoming increasingly ineffective in boosting AD and the economy. 

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By March 2009 the economy was in a severe recession and a deflationary spiral was a serious risk.

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The MPC decided to aim for an annual increase in money spending of 5% which evidence suggested would be in accord with keeping inflation close to target.

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Since March 2009 the base rate has remained at 0.5% which is the longest period that interest rates have been held constant for 60 years.

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The Bank used QE to inject a total of £200bn into the economy up to early 2010. There was then a gap of 18 months before slowing growth led to a second round in October 2011, with a total of £375bn being allocated in total.

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QE: Why, when andhow much (2)?

The organisations that sold the gilts to the Bank now had money in their accounts which could be used for investments or loans, with the hope that AD would be raised.

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Buying up gilts raises their market price and lowers their yield which should encourage more organisations to buy other assets such as shares or company bonds whose returns will now be relatively higher. 

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QE puts upward pressure on the prices of a range of assets, which should increase the availability and reduce the cost of finance to companies. 

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How was itmeant to work?

QE also boosts the value of people’s wealth, which should encourage more spending. 

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The main downside is if banks decide not to lend out this extra money but hold on to it to make themselves more secure. 

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Monetary policy affects the economy and inflation with a long and variable time lag.

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It will take QE time to work its way through the economy and it is too early to evaluate its full effects. 

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The Bank argues that without it the recession would have been deeper with more jobs lost and companies gone bust. 

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The Bank suggests that the first QE injection (QE1) had the effects hoped for with gilt prices rising by about 20% and yields falling by 1% more than they otherwise would have. Equities also rose by about 20%. 

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The impact of QE (1)

The Bank estimates that QE1 raised real GDP by between 1.5-2.0% and inflation by between 0.75-1.5%.

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The £375bn of QE is equivalent to £6,000 for every man, woman and child or 26% of UK annual GDP. 

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With fiscal policy committed to achieving a balanced budget, monetary policy has had to operate virtually alone in tackling the deflationary effect. 

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QE has also had a downward pressure on sterling’s exchange rate, which has helped export-led growth. Although this has been partially offset by funds flowing into the UK since the UK has been seen as a safer place to invest funds than many other countries. 

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The impact of QE (2)

Some observers were in favour of the initial use of QE but have become less enthusiastic over time.

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Allister Heath has concluded that “Our central bank is now financing almost one sixth of all public spending on an almost permanent basis, blurring the distinction between monetary policy and fiscal policy...”

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But QE also has a distributional effect, with negative real interest rates having punished savers, although borrowers have benefitted. 

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The case against QE (1)

The Bank estimates that savers have received £70bn less in interest on their deposits than they would have done, whereas borrowers have paid £100bn less in interest. 

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Some argue that it would have been better to have given physical money to consumers, as their high marginal propensity to consume would have been more effective in stimulating AD.

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But, this would not allow the Bank to sell the gilts they have bought back to the market at a later date and delete the money from their account. 

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This should help to prevent inflation taking off as a result of the excess money supply. 

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But, this reversal will be difficult to achieve at the correct stage of the economic cycle. 

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The case against QE (2)

This reversal may not even happen as the Bank has bought up one-third of total UK government debt and they may be pressured to write this off.

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In November 2012 it was announced that the £35bn in interest earned on the bonds bought through QE would be remitted to the government.

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This helps to reduce the government’s deficit and has led to questioning the degree of independence that the Bank actually has. 

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It illustrates the blurring between monetary and fiscal policy and can be seen as a short-term fix to held the Chancellor present the best possible state of the public finances at the time of his Autumn Statement. 

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The case against QE (3)