Following the Bank of England and ECB’s moves to cut interest rates by a further 50bp, “quantitative easing” has become the theme du jour. Understandably perhaps, the Bank’s decision to “create” £75bn worth of new money to pump into the UK economy over the next three months has raised concerns about what the FT describes as “perceptions that Britain was following the policy of Zimbabwe into bankruptcy and hyperinflation”.
Such perceptions clearly drove the Bank’s governor Mervyn King to give a series of rare interviews, to reassure everyone the Bank knows what it’s doing. In only his second broadcast interview since the credit crisis started 18 months ago, King said: “The amount of money is not growing at all, and the economy is in a recession, so we need to increase the supply of money.”
We hope – and presume – that’s the case. But as the FT notes, in a particularly scary part of Friday’s report:
There are few good comparisons for the bank’s policy move, with only Japan and the US having previously reached the lower limit of normal monetary policy.
Officials hope quantitative easing will work both by raising the price of gilts and so reducing borrowing costs across the economy, and by increasing the money in the system available to be spent or lent by banks.
But with few precedents, the [Bank's] monetary policy committee is very uncertain of the likely effects
That’s reassuring.
And as the FT notes in a Friday editorial comment on the process known colloquially as “printing money”:
…in truth, money will be created electronically — as it is daily within the world’s central banks. The difference between quantitative easing and conventional monetary policy is that rather than setting the prices for credit, central banks use their tools to increase the supply of money. The financial system must still be fixed but easing aims to loosen credit and liquidity conditions directly.
More disturbingly, perhaps, the FT notes that the Bank “will be increasing the money supply when it freely admits that it does not know the multiplier effects which exist between the supply of money and output. It will be experimenting...” (our emphasis).
But “while allusions to the debased currencies of Weimar Germany and modern Zimbabwe are common, they are wrong,” says the FT:Quantitative easing will not lead to hyperinflation. Inflation is now too low, and new money can be destroyed extremely rapidly.For those who still have niggling doubts and concerns, here’s an “easy guide to quantitative easing” from The Telegraph on Friday which outlines options including “the helicopter drop” technique. More seriously, however, it also has a neat explanation of the mechanics of creating – rather than printing – money:
How does it work? The Bank buys assets off private investors but funds those purchases by creating money (literally, with the push of a button; metaphorically, with printing presses). This is what the Government has now approved. The aim is to increase the amount of money in the economy, which will in turn increase either economic growth, inflation, or a combination of the two.
Pros: The UK faces a possible spate of debt deflation, and there are few more powerful weapons for a central bank to use than its printing presses. It can also aim to kill two birds with one stone and cut the cost of borrowing for companies by making cash more plentiful. With interest rates at zero, there are few other more powerful tools the Bank can employ.
Cons: In normal times, such a policy is potentially highly inflationary. There is every chance the Bank is unconsciously laying the ground for an uncontrollable wave of inflation in the future. Deflation is the big enemy at present but the threat may be overblown, and printing money — quantitative easing — will create a mess of unparalleled proportions to clear up afterwards.
Does it work? Yes and no. The only other time it has been used is by the Bank of Japan. As Japan is still trapped in stagnation, many say it failed. However, there is evidence the Japanese experience would have been worse had it not taken these measures. Some also argue that the BoJ was too slow to start quantitative easing.
Related links:
Bank of England pumps £75bn into UK economy – FT
BofE, ECB cut rates - FT
Two central banks 0nly one answer - FT