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!
----
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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