At the current juncture, however, a scarcity of funding and capital is likely to make banks cautious about doing this. That was exactly what happened in Japan during its so-called “lost decade”. But there are signs that the extra reserves may be contributing to a decline in the interest rate that banks pay to borrow from each other. It will take some time before we can assess just how effective Quantitative Easing has proved to be. Our latest assessment is that the combined stimulus from policy easing and the lower value of sterling should be sufficient to lead to growth resuming as we move towards the end of the year. But the continuing drag from the financial sector means that the ensuing pickup is likely to take place relatively slowly. There is, however, considerable uncertainty surrounding that assessment. Our primary objective is, of course, to control inflation, not growth. Our target measure, the Consumer Price Index, has been running above the 2% target for the past eighteen months, reflecting in particular the surge in energy and other commodity prices during the first part of last year. But it is now dropping back, reflecting both the sharp decline in energy prices in the latter part of 2008 and the growing margin of spare capacity in the economy. We expect it soon to fall below target and it is more likely than not to remain there for the next year or two.
But given the strong contractionary tendencies in the economy, we decided that further stimulus was needed. So in March, we announced a programme to purchase £ bn of public and private financial assets, financed by issuing extra Bank of England reserves – an action going by the unlovely description of Quantitative Easing. And at our meeting at the beginning of this month, we upped the total amount of purchases to £ bn, about half of which have so far been made. The ultimate aim of these measures is to boost the annual rate of growth of nominal spending in the economy, which has been roughly flat over the past year, to a level consistent with a sustainable level and rate of growth of real activity and inflation meeting our target. Quantitative easing has been described in some quarters as “printing money”, though it is not literally that. It is more akin to us buying the asset with a cheque drawn on the Bank of England, which the seller then deposits with his own bank. As a consequence, the quantity of bank deposits in the economy goes up, while the claims that the banks hold on the Bank of England also increase. The immediate impact of these purchases should be to drive up the price of the assets that we are buying, or equivalently to reduce their yield. That is indeed what we have seen, with gilt yields falling nearly ½ percentage point when the programme was initiated.