Magazine article Public Finance

Is the Bank's Rescue Remedy Working?

Magazine article Public Finance

Is the Bank's Rescue Remedy Working?

Article excerpt

The news that the Bank of England was to expand its radical quantitative easing programme - colloquially known as 'printing money - came as research indicated that the UK economy was continuing to shrink.

Data published by the National Institute of Economic and Social Research on November 5 showed that gross domestic product fell by 0.4% in the three months to October. It suggested there had been no improvement on the month before, and that the UK economy was stalling as its global peers were pulling clear of recession

All this, eight months after the Bank's Monetary Policy Committee brought interest rates to an historical low of 0.5% and signed off an initial £75bn of QE to jump-start the economy. Two £50bn injections followed in May and August The latest £25bn batch, announced on November 5, will be released over the next three months.

Under QE, the central bank creates new cash, which it spends on assets such as corporate and government bonds. The policy was pioneered by the Bank of Japan in 2001 to fight deflation The US Federal Reserve used a similar mechanism last year to acquire mortgage-based assets during the global finance crisis.

In the UK, the Bank has overwhelmingly bought government bonds - or gilts - from bodies with substantial investments such as pension funds and banks. In theory, the new liquidity finds its way into the wider economy, opening up the flow of credit

Fears that the measure would lead to Weimar Germany-style hyperinflation have so far proved unfounded. QE has been credited with the partial reversal of last year's house price crash but its most obvious effect has been to push up asset prices. This has led to a rally in the stock markets that some believe is unsustainable as it is significantly at odds with the performance of the wider economy.

So it was perhaps surprising that economists have broadly welcomed the latest announcement. Liberal Democrat Treasury spokesman Vince Cable provided a rare voice of dissent, accusing banks of 'hoarding' the cash, which he said was preventing it trickling down to the grass roots.

Roger Bootle, economic adviser to financial consultancy Deloitte, says the strategy is helping, and that there are few other options. 'If the government could put together a programme to make people more confident, there might well be more lending and borrowing and spending,' he told Public Finance.

'But it's not easy to do that In terms of broad macroeconomic levers, or buttons you can push, there are none available apart from QE.

'Could the public sector spend a lot more, or give tax cuts? It could, but then you get into the problems of deficit The point about QE is that it does not affect the deficit, at least not directly. It's not affecting the solvency of the state.'

Strangely, QE appears to be making markets more confident - despite sending out a strong signal that the economy is so stricken that it requires stronger stuff even than holding the Bank of England base rate at an all-time low for months on end.

Charles Davis, senior economist at the Centre for Economics and Business Research, concedes that the policy might not yet have boosted bank lending to households and small businesses. But, he says, it is encouraging investors to be a little more adventurous - partly reversing the extreme risk-aversion that led to the stock market freeze a year ago.

Davis says that in buying up large amounts of gilts, QE has lowered the yields on those bonds - in effect, raising the price of them, making them less attractive to investors. …

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