Economics for Non Economists 2 – Quantitative Easing Explained

by Girish Menon

Pradhip, you have asked for an ‘Idiot’s guide on Quantitative Easing and how it affects the economy’. Let me try:

The Bank of England (BOE) has been practising Quantitative Easing (QE) since 2009. The amounts are:

Time	Amount in £ Billions
Nov. 2009	200
July 2012	375
Aug. 2016	435
Mar. 2020	645
June 2020	745

Ref – The Bank of England

What exactly did the BOE do when they said they were doing QE?

The BOE created additional digital money and used it to buy financial assets (especially government bonds) which were owned by the privately owned banks, pension funds and others.

How did they create this additional money?

Unlike you or me who would be arrested if we did this; the BOE has been conferred with monopoly powers to conjure up any amount of money from thin air by typing the necessary numbers into its bank accounts. It’s as simple as saying, ‘Let there be £745 billion and it appears in the bank’s accounts.

Why do they do QE?

Post the 2008 financial crisis there was a liquidity crisis (see below for explanation of liquidity crisis). The BOE by buying the government bonds from local banks transferred cash to them thus enabling them to start their lending activities in the economy.

In 2020 too they have done the same, but this time I suspect that even if the commercial banks are willing to lend there may not be enough borrowers and so this policy may not have the intended effect of stimulating economic growth.

How does QE affect the economy?

The dominant worldview is that debt drives the world. So QE ensures that lenders have enough money to lend to prospective borrowers. Borrowers borrow money to produce and sell goods at a profit; enabling them to repay their loans with interest while creating jobs in the economy.

The above borrower will use his loan to buy machinery, employ labour…. One man’s spending is another man’s income, so the money begins to circulate among citizens in an economy and a positive spiral will push economic growth and create employment.

However, all this theory hinges on the citizens’ confidence about the future. In the current Covid climate, with firms downsizing at will and people worried about their future, I doubt if there will be a critical mass of borrowers to re-start the stalled economic activity.

Pradhip, thus the BOE does indeed have a magic wand to create money out of thin air. You may ask why is it that in a free market I am not allowed to create my own money? Now that question will be considered seditious!

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What Is a Liquidity Crisis?

A liquidity crisis is a financial situation characterized by a lack of cash or easily-convertible-to-cash assets on hand across many businesses or financial institutions simultaneously. In a liquidity crisis, liquidity problems at individual institutions lead to an acute increase in demand and decrease in supply of liquidity, and the resulting lack of available liquidity can lead to widespread defaults and even bankruptcies. (Ref Investopedia)

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