Quantitative Easing: Is it worth it?
Quantitative Easing was introduced in the UK in March 2009, with the bank rate already at 0.5%, the MPC had to turn to a different stimulus in order to boost the economy. The Bank of England creates new money, boosting the money supply, in order purchase government bonds. The purpose of this is to inject money directly into the economy in order to boost demand at a time of deep recession. Currently, £375 billion of gilts have been purchased, with the MPC currently split as to whether to boost it further, with David Miles suggesting this needs to be done in order to decrease the output gap.
QE has benefited the economy, providing additional stimulus to the economy; one of the only tools available to the Bank with interest rates having no room to decrease. At a time of recession, something was needed, with the decreasing demand leading to downward pressure on prices. Therefore, without the injection that QE provided, it was possible that the UK could have seen deflation, leading to consumers holding money and causing even more issues in the economy. Deflation damaged the Japanese economy and led to stagnation for almost two decades, meaning that it had to be avoided. At the same time, the financial system was very weak, and the funding that QE provided has helped the sector to boost their balance sheets, again possibly avoiding further damage.
With bonds purchased from investors, they have free money which can be invested elsewhere, due to the falling returns. This means that they purchase other assets, such as stocks, in turn increasing the value. This effect has been seen worldwide, with both the FTSE and Dow Jones exchanges reaching record highs. Particularly in the US, each programme of QE has boosted the S&P500 by at least 10% annually. Wealth increases and companies become more confident, helping to drive investment and job creation, further boosting the economy. Studies have found that QE has boosted GDP by around 2% since it was created. Without QE, the economy would be in a lot worse condition, setting back recovery even more, and with economies still struggling to return to solid growth, this would likely mean a substantially deeper recession, proving that QE was needed.
Despite this, QE also has numerous disadvantages. As economic theory suggests, when you boost the money supply, inflation is always a possibly. Even with QE, the Bank’s main objective is still to control inflation, therefore QE directly conflicts with that. The purchase of bonds leads to the government spending, increasing the money available to people, leading to more spending, which could in turn lead to increased prices through increased demand. Studies have shown that QE has boosted inflation by 1.5 percentage points, leading to higher inflation, possibly creating further problems, including lower demand, hurting the economy. However, so far, it hasn’t been a major issue, with banks keeping lending low, reducing the money multiplier and reducing the impact of money supply growth. If lending recovers, and the money multiplier recovers, this will dramatically increase the amount of money available, likely leading to very high inflation in double figures, meaning that the Bank loses credibility – damaging future opportunities, such as investor confidence.
Even though QE is easy to carry out, at some point the Bank will have to reverse the move, decreasing the money supply. This has real potential to cause damage, possibly leading to another recession as investors sell and stock markets decrease. This effect has been seen in the US, with stock markets decreasing by around 10% when QE programmes had ended. The risk is so major that JP Morgan have described it as the “single largest systemic risk”. Any move to end QE is likely to be interrupted by the market as bad news, reversing the gains made under QE and leading the country back into recession. Even if the economy is seeing steady growth, any exit will likely lead to a change in sentiment, making it difficult to pick anytime to end the programme. This downside means that there could definitely be long term pain, with the effects lasting for many years, potentially leading to even more QE and a never ending cycle.
Overall, it is clear that QE has benefitted the economy in the short term, helping to avoid deflation and provide a stimulus to the economy, pushing stock markets higher and boosting GDP growth, with few other policy options available. Although not in a great condition, the economy is in a better condition with QE than it would be without. Despite this, the impact has been difficult to measure and research has also suggested that although the first round of QE was good, additional packages have had little impact. However, there is huge potential for inflation problems, especially when banks return to lending and exiting QE is likely to be a very dangerous situation that could push the economy back into recession, creating long term pain for short term gain. Potentially, the first round of QE should have been carried out, bringing the boost, but further rounds, making it harder to exit, weren’t worth the disadvantages.