Quantitative easing – the key questions

What does the decision by the Bank of England to begin a new bout of electronic money creation mean for the UK economy?
Bank of England Quantitative Easing protest
Quantitative easing has fierce critics, such as this protester outside the Bank of England on Thursday. Photograph: Andy Rain/EPA

What is quantitative easing?

A radical, last resort scheme to boost economic demand and fend off deflation and recession. When interest rates are already at record lows, central banks have to resort to so-called "unconventional measures" to kick-start growth.

Quantitative easing involves electronically creating money, which the Bank of England uses to buy assets – mainly government bonds, known as gilts – from investors in financial markets. The bank doesn't actually print the cash; it just credits investors' accounts.

Why is the Bank doing this now?

It is seriously worried about the prospects for the UK economy, and the risk that the eurozone crisis could spiral out of control.

The latest GDP figures for the UK showed that the recovery from the recession had ground to a halt even before the summer, when the riots in Athens and political paralysis in Brussels and Berlin sent financial markets into a tailspin.

In its statement on Thursday, the Bank's Monetary Policy Committee (MPC) listed "vulnerabilities associated with the indebtedness of some euro-area sovereigns and banks"; "the squeeze on households' real incomes," and the "strains in bank funding markets" as reasons for taking action. In other words, it believes this is an emergency situation, that requires a drastic response.

How is QE meant to help?

In two ways: first, it pushes up the price of the bonds the Bank buys. The higher the price of a bond, the lower the interest rate the borrower has to pay; so the "yield" – the interest rate – on government bonds falls. Since many interest rates, including mortgage rates for example, are set with reference to gilt yields, QE should therefore help to drive down borrowing costs.


Will it work?

As with most things in economics, opinion is sharply divided: the Bank recently published research suggesting that the initial £200bn bout of QE, starting in 2009, boosted GDP by around 1.5 percentage points – though given that the UK still experienced its worst recession in living memory, it was hard to feel the benefit at the time.


What about the "credit easing" George Osborne announced in his conference speech?

The chancellor said in Manchester on Monday that the Treasury was drawing up measures to increase the supply of credit to small and medium-sized businesses, which have repeatedly complained that they are missing out on loans from the crisis-hit banks.

In theory, the Bank could have used its electronically-created money to carry out Osborne's credit easing; but No 11 says it's happy to use taxpayers' money to invest in the scheme instead – and anyway, Osborne hasn't yet worked out the details.

Adam Posen, the independent American economist on the MPC, gave a recent speech arguing that alongside a large increase in QE, which he has now been advocating for a year, the Treasury and Threadneedle Street should work together to set up a new state-backed bank to lend to small firms; and create a new organisation to bundle up and sell loans to small businesses.

What does this tell us about the Coalition's economic policy?

It's hardly a vote of confidence from the Bank. Osborne could do little about the crisis in the eurozone which is top of the Bank's list of threats to the UK. But the squeeze on living standards also cited has been exacerbated by the chancellor's January VAT rise, and the Bank clearly sets little store by his much-vaunted "plan for growth".
