This piece first appeared in The Oldie in December 2012
The text here may not be identical to the published text  

Modern Times

Quantitative Easing explained

Printing money is easy to understand. A Government, short of cash, turns on the banknote presses and pays civil servants and suppliers with the new notes. But that means more money chasing the same amount of stuff. So prices go up. That means more money has to be printed and prices rise again. When Zimbabwe tried it in a few years ago inflation went super then hyper then ran out of prefixes. Before the crisis ended Government presses were turning out notes of one hundred trillion Zimbabwe dollars. That’s Z$100,000,000,000,000. Each was worth 33 US cents. Printing money is a Bad Idea.

So why is our very own Bank of England, cautious custodian of the national finances since 1694, now doing it? The Bank calls it QE. And if you thought Quantitative Easing was a heavy duty laxative, in a way it is. A lubricant for the logjam which stops banks lending to businesses which stops businesses growing which keeps the economy in the doldrums which stops banks lending to businesses which… you get the picture. Here’s how it works.

Every year the Government spends more than it raises in tax. In 2011/12 the shortfall was £126 billion. The Government covers that gap by borrowing. You lend it £100 and it gives you a piece of paper – a Government bond – promising your money back at a future date and paying interest twice a year until then. These bonds are bought by pension funds, banks, and foreign states. Although the interest rates are low – less than 1% in many cases – the lenders are (virtually) certain they will get their money back at the end of the bond’s life.

Money lent to the Government is dead – the lender can’t use it. So the Bank came up with the wheeze of buying back the debt. The lender gets money to spend and the dead money – the bonds – goes into the Bank’s safe. To buy them the Bank magics money out of thin air. It doesn’t physically print it – the Bank hates the phrase ‘printing money’ largely because it doesn’t want to be compared to Zimbabwe. It is ‘created electronically’. In other words it just puts positive numbers into the firms’ bank accounts.

If the firm is a bank then it can lend this new money out to others – though even the Bank admits banks are in fact hanging onto it. If it is a manufacturing business it can invest it in plant and machinery and create jobs. And QE has another stimulating effect. Buying back Government bonds creates a demand for them. That raises their price and makes the yield – the fixed return on that higher price – lower. That brings down all interest rates making it easier for businesses and individual to borrow. And that boosts the economy.

That’s the theory. But after £325 billion of QE, lending is still sluggish and the economy still shrinking. The medicine is not curing the illness. But it is having serious side effects. The return on savings is very low. Inflation is persistently high – the first tranche of QE put inflation up around 1.5 percentage points. And the low yields on safe investments mean someone buying a pension now gets a quarter less for their money than one bought in 2008.

But Doctor King, aka The Governor, believes the illness would have been far worse without his QE potion. So now we just need one more heave. Magicking up another £50 billion is under way. There will be more after that. If he’s wrong the blockage will remain as bad as ever and the side effects get worse.

You couldn’t make it up. Except the Bank has – 375,000,000,000 times.


All material on these pages is © Paul Lewis 2012