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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?

 

Money has flooded into stock markets and into emerging markets as investors look for yield.

Bernanke (pictured) and Bank of England governor Mervyn King have said it is clear that quantitative easing has boosted stock markets. Both hope that will in turn improve confidence and boost demand. 

But emerging market governments have become worried that the flood of cash coming their way could destabilise their economies.

So will we have more quantitative easing in the UK?

Much depends on whether inflation continues to remain above the 2% target – which is increasingly likely given the VAT rise in january and the strength in commodity prices.

If growth remains strong and there are signs that demand is growing, the Bank of England may decide against doing more to stimulate the economy.

But one member of the Bank's rate-setting Monetary Policy Committee, Adam Posen, has already voted for more stimulus and other rate-setters including deputy Governor Paul Tucker say the case for  more stimulus is growing as the outlook for the UK is lacklustre.

Any more stimulus is unlikely before February, by which time the committee will have a better view of how the recovery is developing.

What could go wrong?

Most commentators agree that quantitative easing has little impact on the real economy and is largely a confidence game so data last week that showed consumer confidence has fallen back to lows last seen at the peak of the crisis in November 2008 is a worry.

The Bank of England's Charlie Bean has said it is vital that we spend our savings but some data suggests people are already raiding their piggy banks just to pay for the higher cost of living and that means they are reluctant or incapable of spending on any luxuries.

And with banks still nervous about whether they will be forced to hold more cash aside for a rainy day and reluctant to lend in this uncertain economic environment, it is possible that cash could remain in short supply and spending will remain muted.

Could anything else go wrong? 

The risks are hyperinflation and the collapse of sterling. In the days when governments actually printed more cash, this has traditionally been the end result of easing.

Sterling did fall back after the first bout of stimulus but has recovered much of the ground lost in recent months as the economic picture has improved and as it became clear the US would be first to do more quantitative easing.

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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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