What is Quantitative easing?
Quantitative easing (QE or ‘asset purchasing’) is a tool used by central banks to invigorate an economy when ‘conventional’ monetary policy tools have failed or need to be supplemented.
The approach was first used in the UK in 2009.
How does quantitative easing work?
Ordinarily, a central bank (such as the Bank of England) will lower interest rates in order to encourage greater lending and spending.
However, if interest rates have been cut as low as possible and economic activity has not improved, then the central bank may inject a ‘quantity’ of money directly into the wider economy to boost the money supply and ‘ease’ the situation – i.e. ‘quantitative easing‘.
The central bank does this by firstly creating a batch of ‘new money’, not by printing actual bank notes, but by simply crediting its own bank account electronically. It then uses this new money to buy assets and complete bond purchases, from private sector businesses including high street banks, pension funds and insurance companies.
When central bankers buy up assets, their price rises and the yield (return or interest) on those assets falls. The sellers of those assets are then likely to use their new money to buy other assets such as equities and corporate bonds, which depresses yields further. Reduced yields mean the cost of borrowing is reduced for businesses and individuals and as a consequence lending, spending and investment should all increase.
Also those banks which have increased funds in their account from the sale of assets should in theory be more inclined to provide loans, which again will lead to increased spending and investment.
When the economy recovers, the central bank can then sell the assets it has bought and removes the cash it receives for those assets from the economy, so that in the long term no new money has been created.
Why is quantitative easing necessary?
The aim of QE policy is simple: by creating ‘new money’, the Bank of England looks to boost spending and investment in the economy.
When the global recession took hold in late 2008, the Bank of England lowered the Bank Rate from 5% to 0.5% to support the UK’s economic recovery. However, such a ‘conventional’ monetary policy tool proved ineffective in this unconventional period of economic downturn.
The lowering of the Bank Rate did not encourage the opening and investment the Bank of England hoped it would, and having lowered the base rate. to 0.5% there was no longer much room to lower it again. Furthermore, if lowering the base rate from 5% to 0.5% had made little difference, it was questioned as to what help lowering the bate rate further would provide.
By embarking on a Quantitative Easing program and asset purchasing, therefore, (through the process described above) the Bank of England could secure a lower interest rate through another means.
This lowering of interest rates makes it cheaper for households and businesses to borrow money – encouraging spending and economic recovery.
History of Quantitative Easing in the UK
Quantitative Easing after the 2008 Financial Crisis
Quantitative easing was first used in the UK in 2009. The collapse of US banking giant Lehman Brothers in September 2008 precipitated a worldwide financial crisis which by 2009 had developed into a serious global economic downturn. World GDP was forecast to fall to its lowest rate since World War II and in the UK GDP was down 2.4% in the first quarter of 2009.
The Bank of England’s Monetary Policy Committee had already set the bank rate as low as possible at 0.5%, but decided that in order to meet the inflation target of 2% further action was needed. The Monetary Policy Committee announced in March 2009 that it would begin to inject money directly into the economy – the process known as quantitative easing.
The then Governor of the Bank of England, Mervyn King, said, “It’s fair to say that in the Bank‘s 300 year history we have not seen measures of this kind enacted on this scale, but remember we haven’t either seen the scale of the problems to which we’ve had to respond.”
The then Chancellor, Alistair Darling, had authorised the Bank in January of that year to set up an Asset Purchase Facility (APF) which would provide a framework for the Monetary Policy Committee to use asset purchases for monetary policy purposes should that prove necessary. In February the Governor of the Bank of England wrote to the Chancellor requesting authorisation to use the facility and in March authorisation was given.
Initially the Bank announced that it would purchase £75 billion of assets using new money it had created. The Governor said it was “hard to judge” whether that would be enough, but that the situation would be monitored to see whether it was necessary “to do more or less”. In May 2009 the Bank decided it would need to purchase another £50 billion of assets bringing the total figure to £125 billion. In August that total figure was increased to £175 billion and in November to £200 billion.
Most of the assets purchased have been UK treasury securities (gilts), but the Bank has also purchased small quantities of high-quality private sector assets in order to support the flow of corporate credit.
The MPC decides at its regular monthly meetings whether or not more assets need to be purchased and in February 2010 the Committee voted to maintain the stock of asset purchases at £200 billion, but added that further purchases would be made if the outlook warranted them.
On 6 October 2011, the MPC increased the limit of the current purchase programme to £275 billion and on 9 February 2012 to £325 billion, with a further increase of £50 billion to a total of £375 billion on 5 July 2012.
On 9 November 2012, the Treasury announced that the Government had agreed with the Bank of England to transfer to the Exchequer the excess cash held in the Bank‘s Quantitative Easing (QE) facility.
This move would align the cash management arrangements for the facility with normal government practice and with the approach followed by other countries undertaking QE.
The Treasury stated that with the purchases of the APF having reached £375 billion in July 2012, the Facility had now accumulated a large cash balance; and as the scale and likely duration of the scheme had increased significantly since its inception, “it makes sense to normalise the cash management arrangements for the APF.”
Quantitative Easing post the Brexit referendum
In the aftermath of the EU referendum 2016, the Bank of England cut interest rates for the first time in 7 years. It also pumped an additional £60bn in electronic cash into the economy to buy government bonds, extending the quantitative easing (QE) programme to £435bn.
Quantitative Easing and COVID-19
The COVID-19 pandemic delivered the sharpest economic contraction on record, with the UK economy declining by 9% in 2020 alone.
The Bank of England began another Quantitative Easing program in the hope of reducing the borrowing costs of households and businesses and stimulating the economy in the long run.
In November 2020, it was announced that the Bank of England would pump £150bn of Quantitative Easing into the British economy. Following this additional programme, the Bank of England’s purchasing of UK government bonds totalled £875 billion.
Quantitative easing itself also has implications for the cost of government borrowing, and the associated cost of financing the national debt. Through Quantitative Easing, the government has been buying its own bonds back again in the secondary market. This is sometimes also referred to as the Asset Purchase Facility, as the government creates new digital money to help stimulate the economy. In doing so, it also reduces the net interest rate cost of UK government debt.
Quantitative Easing around the world
Japan
Japan was the first country to employ Quantitative Easing, with its program beginning in 2001. Lasting five years, this programme failed to rid the world’s third largest economy of its persistent deflation. Japan restarted their QE program in 2013, this was worth $1.4tn (£923bn). This formed part of a set of policies known as Abenomics – named as such after Japan’s former PM: Shinzo Abe.
United States
Like the UK, the US Federal Reserve System embarked on its first QE program in 2008 in the depths of the financial crisis. It was launched by then Federal Reserve chairman Ben Bernanke – dubbed “Helicopter Ben” because of his supposed desire to drop money out of the sky. The US economy slowly improved after the beginnings of the Quantitative Easing program, and US shares rose rapidly from 2008.
Controversies around Quantitative Easing
One of the main concerns about quantitative easing is that if too much new money is created, this can lead to hyperinflation, as was seen in the German Weimar Republic after World War 1 and latterly in Zimbabwe, where increasing numbers of banknotes were printed of ever higher denominations until they became virtually worthless.
In the past, the Governor of the Bank of England has rejected the comparison, pointing out that the Bank is not printing vast amounts of new bank notes and insisting that the amount of new money being electronically created is not big enough to generate “anything remotely like” that kind of situation.
Another concern is that quantitative easing will be ineffective if instead of using the new money to lend to small businesses and individuals, banks just sit on the cash in order to increase their capital reserves. But the Bank of England disputes this, pointing out that quantitative easing operates through a variety of channels, only some of which actively involve commercial banks.
Others have criticized how quantitative easing benefits those households with assets and investments The Bank of England themselves calculated that the value of shares and bond prices had risen by 26% – or £600bn – as a result of Quantitative Easing.
Quotes
‘Long before folks fretted the demise of ‘quantitative easing,’ I fretted its existence. It proved the reverse of its image, an anti stimulus, and we’ve done okay not because of it, but despite it’. – Kenneth Fisher, American author
‘There is a fundamental divide in British politics at the moment. Some people would withdraw the fiscal stimulus now at a time when the economy is still in difficulty, some people would stop quantitative easing today and that would imperil the recovery’ – Gordon Brown, 2009
