If you need £150bn in a hurry, printing it is probably the quickest way to get it.
Quantitative easing (QE) is one of the main tools the Bank of England can use to influence the economy. It is often referred to as money-printing, though these days it’s all done digitally.
When the Bank of England announced it would pump another £150bn into the British economy, taking overall spending to £895bn, it was talking about extending its QE programme.
What is quantitative easing?
Quantitative easing is one of the primary ways central banks can support their economies, and it’s basically a way of creating money. In crises, high street banks lend less, but at the same time people are still repaying loans – shrinking the amount of active money in the economy. QE is a way to create money when banks aren’t doing so.
This process is done digitally, and central banks then use the new money to buy things that will bolster the economy’s spending power.
The most typical thing to spend QE cash on is government bonds.
What are government bonds?
Effectively, government bonds are an investment where the central bank lends the Government a sum of money for an agreed period of time, plus interest.
By spending billions on these bonds, the price of those bonds goes up because they are suddenly more popular: it’s simple supply and demand. When a bond’s price goes up, the interest rate goes down – it is a mechanical link between price and rate. That means it becomes cheaper for the Government to borrow.
Government bonds are a core part of the financial system, and are generally seen as the closest thing you can get to a ‘risk free’ asset. As a result, government bond prices influence other financial instruments, such as banks’ interest rates on loans to people and businesses. Lower interest rates in turn make it easier for people to borrow money and therefore to spend that money, boosting the economy.
If borrowers benefit, the opposite is true for lenders. QE also reduces the yield (the interest) investors can expect on those government bonds, because of their popularity: they get pricier to buy and offer less interest because so many people want them.
That means if investors want a higher return, they have to look at taking more risk. Instead of government bonds, they may put their cash into corporate bonds, or into stocks, or lend it to others, putting that money into active circulation in the economy.
Where does QE money go?
When central banks create money, they create what they call central bank reserves. They use these to snap up government bonds, normally from pension funds and insurers. In exchange, the pension fund or insurer gets a deposit of money in an account at a major bank, which in turn receives an asset – part of that central bank reserve of newly created money.
That means quantitative easing both increases reserve money – only used between banks – and money that can go into active circulation in the economy.
How does QE impact pensions?
The pension fund or insurer that sold its government bonds might then invest that money in other financial assets, such as shares, the value of which then rises.
Anyone whose retirement funds are invested in the stock market will theoretically see the value of their pension pots rise. Shareholders – who could be individuals or companies – also see their wealth improve, encouraging them to spend more themselves.
How effective is quantitative easing?
Quantitative easing use in the UK only goes back around 10 years. In March 2009, at the height of the financial crisis, the Bank of England slashed interest rates to 0.5pc (five times higher than the current record low) and pumped money into the economy.
Overall it spent £200bn, before a second tranche of £375bn in 2012.
The policy broadly worked as planned, lowering the cost of borrowing for households and businesses in order to encourage economic activity via lending and spending.
But the Bank also discovered some undesirable side effects: the price of stocks increased as investors steered clear of bonds, and house prices also rose after an initial fall. That broadly benefited wealthier people who already had such assets, the Bank found, and made them less attainable for young people.
The rising price of government bonds is also used to determine the future cost of providing pensions: that means companies must pay more into employees’ pensions schemes, limiting how much capital they have to spend on other things.