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Ask Citywire: Quantitative easing part II

The US has launched the second round of quantitative easing, or QEII, and the UK is still pondering whether it should follow suit. But what is it and how does it work?

 

While Bank of England's rate-setters have so far voted against a second round of ‘quantitative easing’ most commentators believe there is a strong possibility that the Bank will begin buying up more bonds in 2011 as the UK recovery is likely to slow.

What is quantitative easing?

Ben Bernanke, the chairman of the US Federal Reserve, is one of the world's leading supporters of quantitative easing. Back in 2002 he made a speech saying that central banks can always tackle deflation by printing money and likened that process to dropping dollars from a helicopter.

The process involves a central bank, in our case the Bank of England, buying assets from commercial banks or other financial institutions such as insurance groups and pension funds.  

Quantitative easing - often referrred to as printing money - was first introduced in Japan back in 2000 and was used again by the US, the UK and Japan in the wake of the 2008 financial crisis as a way to get money circulating again and to stimulate demand after markets froze up. 

Why are the central banks doing more quantitative easing?

The US has launched a second round of quantitative easing because unemployment remains just shy of 10% and data suggests the US is on the verge of deflation - an economic problem that is very difficult to tackle.

Japan has also begun pumping more money into its economy. The US said it will buy medium dated governemnt bonds to help bring interest rates lower while Japan has pledged to buy exchange traded funds and real estate investment trusts as well as corporate bonds. In the UK, the Bank of England has also mostly been buying governemnt

Banks in the UK remain reluctant to lend and demand remains in the doldrums with consumers and businesses still nervous about the pace of the recovery and the likely impact of government spending cuts.

Chancellor George Osborne has said that if its cuts have a larger than feared impact on growth, the Bank of England can launch a second round of quantitative easing. 

But inflation is a bigger worry in the UK than in other developed countries and recent economic data has been better than hoped, casting doubt on whether more stimulus is needed.

Is it working?

The extra money is meant to stimulate investment, consumption and other economic activity but the evidence so far has been mixed.

There has been one clear beneficiary: stock markets and other risky investments such as commodities have risen. 

Global stock markets have been boosted as low interest rates and the low yield on bonds means investors have been taking on more risk to guarantee a return on their cash.

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5 comments so far. Why not have your say?

John Thorley

Nov 08, 2010 at 14:51

Most exporters are also importers so exchange rate changes have effects in both directions. Inflation will sky rocket if we print more money. Printing money has never solved anything.

People with savings will not spend them just because the B of Eng want them to. With returns to cash so low they'll just stop spending. That's how they got the savings in the first place.

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Hotrod

Nov 08, 2010 at 16:49

Control of the money supply by a central bank using quantitative easing in "open market operations" has come to mean in layman's terms. Printing bank notes.

Of course in reality this is a misnomer and over-simplification. Since most money is now in the form of electronic records no actual printing takes place. The central banks simply make bargains with clearing banks to buy certain assets. (usually Govt. bonds) Payment is in the form of an "electronic" credit. Since it cannot in theory make credits without corresponding debits to its own account the central bank must record that the total amount of money in circulation has increased and by how much.

However the true money supply only increases when specific electronic money is lent to someone who then exchanges it for something real or tangible.

So it may be fair to say that the amount of quantitative easing will ultimately be decided by the number of borrowers who step forward with requests for loans.

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Jeremy Bosk

Nov 09, 2010 at 00:58

People who save more when interest rates are low are missing a trick. They should invest in short term corporate bonds, preference shares, PIBs or better yet in high yielding equities. If any of those things is too much like hard work then buy non-perishable consumer necessities against the long term threat of inflation. Baked beans and soap can only become more expensive in the longer term.

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Gerald Arbage

Nov 22, 2010 at 20:32

"Quantitative easing - often referrred to as printing money - was first introduced in Japan back in 2000"

LOL.

I suggest you guys take a long hard look at this Wikipedia page on Hyperinflation. It contains a long list of countries that printed money before Japan did in 2000. The difference is that Japans economy and currency didn't crash.

I am not saying that 'quantative easing' will cause hyperinflation, nor am I saying it won't. I have no idea what it's long term effect will be. But saying that Japan 'invented' the printing of money is just so plain wrong I could not resist to post.

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Gerald Arbage

Nov 22, 2010 at 20:32

Link to Wikipedia page on Hyperinflation:

http://en.wikipedia.org/wiki/Hyperinflation

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