Tuesday, 14 February 2012

Quantitative Easing - Does it work?????

So time for a bit of thought on such a romantic day!  happy st valentines day to you and the bank of England!!!

Central banks try to raise the amount of lending and activity in the economy indirectly by cutting interest rates. Lower interest rates encourage people to spend, not save but when interest rates can go no lower, a central bank's only option is to pump money into the economy directly. That is quantitative easing (QE).The way the central bank does this is by buying assets - usually financial assets such as government and corporate bonds - using money it has simply created out of thin air. The institutions selling those assets (either commercial banks or other financial businesses such as insurance companies) will then have "new" money in their accounts, which then boosts the money supply.

In March 2009, the England Monetary Policy Committee (MPC) announced that it would reduce Bank Rate to 0.5%. The Committee also judged that Bank Rate could not practically be reduced below that level, and in order to give a further monetary stimulus to the economy, it decided to undertake a series of asset purchases. Between March 2009 and January 2010, the MPC authorised the purchase of £200 billion worth of assets, mostly gilts – UK Government debt. The MPC voted to begin further purchases of £75 billion in October 2011 and, subsequently, at its meeting in February 2012 the Committee decided to purchase £50bn to bring total asset purchases to £325bn but doubts linger over how well its policy of quantitative easing is working

A Bank of England report into the effect of the first round of QE suggested that the measure had helped to increase gross domestic product by between 1.5% and 2%, indicating that the effects of the programme had been "economically significant".  QE worked in 2009. Deflation in the cost of living (the all-items retail prices index measure) peaked at just under 2 per cent (i.e. the price level fell about 2 per cent) in mid-2009. The money stock would have fallen something like 5-10 per cent without QE. The plan to lower bond yields has obviously worked with the 10yr bond falling by 39% in the past 3 years. QE works by the Bank buying bonds in the open market with the demand causing the yield to fall and their attractiveness as an investment to fall as well. This has allowed the UK to maintain a level of bond auctions, and public debt, without too much trouble from the ratings agencies or any vigilante bond traders.

From an inflation point of view the result is less certain. Inflation in the UK has remained sticky throughout the crisis with CPI remaining above the Bank’s 2% ± 1% target since January 2010


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