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Quantitative easing injecting money into the economy

The Monetary Policy Committee announced in March 2009 that it would start to inject money directly into the economy to boost spending a policy often known as quantitative easing. The Committee continues to set Bank Rate each month, and the objective of monetary policy is unchanged to meet the governments 2% inflation target.
What is quantitative easing?
In March 2009, the Banks Monetary Policy Committee (MPC) began purchasing financial assets funded by the creation of central bank reserves. These reserves are new money that the Bank creates electronically. Often known as quantitative easing (QE), the Banks asset purchases are designed to inject money directly into the economy to raise asset prices, boost spending and so keep inflation on track to meet the 2% target. nominal interest rates. But the outlook for demand and inflation in March 2009 suggested the need for further monetary stimulus. So the MPC decided to inject additional money directly into the economy through a programme of financial asset purchases funded through the creation of central bank reserves.

Money is not growing quickly enough to keep inflation close to the 2% target.
How does QE work?
The MPCs purchases of financial assets through central bank reserve creation can boost nominal spending in the economy in a number of inter-related ways. The immediate effect of buying large quantities of gilts is to raise their prices and lower their yields relative to other assets. In response, investors are likely to adjust their portfolios, for example by buying other financial assets like shares or company bonds the return on which is likely to be more attractive. This increased demand for those assets pushes up their prices, and lowers their yield. In this way, the effect of the MPCs purchases of gilts spreads out across all other asset markets. At the same time, those selling assets to the Bank have more money in their bank accounts and commercial banks hold more deposits at the Bank of England. As a result of QE, asset holders in general including ordinary households and businesses will have portfolios with higher value and more liquidity. If they feel wealthier and have more money immediately available, then they are likely to increase their spending which boosts the economy directly, or else to take on more risk by
Supplement Quantitative easing

The Bank is injecting money into the economy to boost spending to meet the inflation target.
The Bank buys financial assets from banks who may be selling on their own behalf or, more likely, on behalf of their clients, such as insurance companies, pension funds and non-financial firms. The proceeds of the sale are credited to the sellers bank account. Most of the assets purchased since the start of the programme in March 2009 have been British government bonds (gilts).

Why is QE needed?
Spending in the economy slowed very sharply in the latter part of 2008 and during 2009 as the global recession gathered pace. This threatened a downward spiral through a combination of contracting real output and price deflation. The MPC responded decisively, cutting Bank Rate from 5% to 0.5% its lowest ever level in just five months in order to support activity and thus reduce the risk of inflation falling below the 2% target in the medium term. Once Bank Rate had reached 0.5%, the MPC considered this to be the practical limit to how far it could cut
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increasing their lending to consumers and businesses. In turn, consumers and businesses may be encouraged to take on more debt because lower yields on financial assets lower interest rates in other words bring down the cost of borrowing. But there are factors that may work to dampen the effects of QE. An obvious example lies in the banking sector. The boost to the value of banks asset holdings and their holdings of liquid assets as a result of QE, by itself, might be expected to make them more willing to lend. But in the wake of the financial crisis, banks are concerned about their financial health and as a result are wary of expanding their lending. For this reason, the MPC did not expect QE to result in a material expansion of bank lending. The Bank has acquired most of the assets from financial businesses other than banks. Charlie Bean the Banks Deputy Governor for monetary policy said that the objective of QE is to work around an impaired banking system by stimulating activity in the capital markets. As a result, companies, particularly larger companies, wishing to raise money have not had to depend as much on the banks as they might have done in the absence of QE, raising funds instead from bond and share issuance.

make another 50 billion of asset purchases, so that total purchases increased to 175 billion. In November the MPC voted to increase total purchases to 200 billion, and to keep Bank Rate unchanged. Those purchases were completed early in 2010.

Pause, continue or exit from QE?

The MPC kept the level of Bank Rate and asset purchases unchanged for almost two years after its meeting in November 2009. The Committee believed that the stock of past purchases, together with the low level of Bank Rate, continued to provide a substantial stimulus to the economy. This extended pause in monetary loosening did not necessarily mean that the MPCs asset purchase programme had come to an end, but it gave the MPC the opportunity to take stock of the effects of QE so far. At its meeting in October 2011, the Committee decided that the outlook for output growth had weakened so that the margin of slack in the economy would probably be greater and more persistent than previously thought. This made it more likely than not that inflation would undershoot the 2% target without further monetary stimulus. Overall, the case for an expansion of the Committees programme of asset purchases was compelling and it voted unanimously to purchase a further 75 billion of gilts, bringing the stock of purchases since March 2009 to 275 billion. Subsequently, at its meeting in February 2012 the Committee voted to make an additional 50 billion in asset purchases, and in July it judged again that further stimulus was required to meet the inflation target and voted to buy another 50 billion in gilts to bring the total stock of asset purchases to 375 billion. Once recovery becomes firmly established, the MPC will likely wish to withdraw some of that extraordinary degree of stimulus, by tightening monetary policy. It is difficult to be sure when that time will come. But the Banks Monetary Policy Committee will continue to be guided by the outlook for inflation relative to the Governments 2% target. If the Bank thinks inflation looks set to rise above 2% in the medium term, the MPC is most likely to withdraw stimulus first through a rise in Bank Rate with asset sales conducted later over a period of time, leaving Bank Rate as the active instrument. This is sometimes referred to as the exit from QE.

How much QE is needed?

There is of course a lot of uncertainty over the appropriate scale of asset purchases. When the MPC first discussed the scale of asset purchases in March 2009, the Committee noted that money spending in the economy had grown each year by around 5% since 1997 and, over that period, inflation had been close to target. At that time, it appeared likely that money spending would contract without additional policy stimulus. That suggested asset purchases needed to be large enough to boost money spending growth back to around 5% a year, bearing in mind reductions in Bank Rate and other factors influencing the economic outlook. So at its meeting in March 2009, the MPC voted to reduce Bank Rate to 0.5% and to spend 75 billion on asset purchases. Subsequently, at its meeting in May that year, the outlook for the economy looked somewhat bleaker than in March. Consequently, the MPC voted to keep Bank Rate at 0.5% and to undertake a further 50 billion of asset purchases bringing total purchases to 125 billion. At its meeting in August 2009, there were still few signs of the fall in economic activity coming to an end. So the Committee again voted to keep Bank Rate at 0.5% and to
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Has QE worked?
Monetary policy affects inflation with a long and variable time lag. So asset purchases like changes in Bank Rate
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take their time to work through the economy to have their full effect on inflation. But what impact has the Banks asset purchases had to date? QE is untried previously in the UK, so theres little past experience to go by. The economic circumstances that necessitated the use of QE are also unprecedented. An article in the Banks Quarterly Bulletin in 2011 reviewed the evidence on the impact of the first round of asset purchases undertaken in 2009. It found a range of evidence suggesting that QE had raised the level of real GDP by 11/@% to 2% and increased inflation by 3/$ to 11/@ percentage points. The Banks forecasting model suggests that a 1 percentage point cut in Bank Rate increases CPI inflation by about 1/@ a percentage point, so that the effect of the first round of QE in 2009 was equivalent to a 11/@ to 3 percentage point cut in official interest rates. But theres still a long way to go, and it is likely that a significant part of the impact of the Banks asset purchases remains to come through. The ultimate success of QE will depend on how far it succeeds in stimulating nominal spending to keep inflation on track to meet the 2% inflation target over the medium term. Its still too early to make a final judgement on that.

For instance, if you think that growth in the economy could be very low, you might decide that justifies more asset purchases; if you think economic recovery is more likely to be strong, that might suggest less. And you need to decide whether you prefer to change Bank Rate or the amount of asset purchases, or both. You will need to watch the MPCs decisions in relation to their projections and judgements about the economy. Like your teams decisions on Bank Rate, the decision on asset purchases will be whether to do more or less than the MPC and if so what amount or the same. This is very uncertain so there are no simple rules. But that is not very different to deciding on the level of Bank Rate. There is no right answer. Deciding on the level of asset purchases or of Bank Rate is a matter of judgement and, like the real policymakers, team members may disagree. Even if team members agreed that interest rates should change, they may disagree about whether rates should go up or down, or about the extent of the change, say, a quarter or a half of a percentage point. Likewise, team members may have differences of view on the appropriate level of asset purchases, or of asset sales. During the preparation stage, the team may choose to vote on Bank Rate and on the level of asset purchases. If this results in a tie, the team captain will have the casting vote. If there is a split decision, both sides of the argument must be explained in the presentation to the judges.

The teams decision

In each round, the team should take the MPCs interest rate on the day of its presentation as its starting point, and decide whether to change Bank Rate and, if so, whether to increase it or decrease it, and by how much. In addition to setting Bank Rate, teams may like the MPC wish to consider the option of injecting or withdrawing money from the economy to meet the inflation target.

Key resources for the teams decision

Watch the Banks short animated film, Quantitative easing - How it works. www.bankofengland.co.uk/education/Pages/ inflation/qe/video.aspx Read Quantitative easing explained, the Banks pamphlet on QE. www.bankofengland.co.uk/monetarypolicy/ Documents/pdf/qe-pamphlet.pdf Watch the Governors ITN interview with Laura Kuenssberg. www.bankofengland.co.uk/monetarypolicy/Pages/ assetpurchases_itvstream.aspx Read The United Kingdoms quantitative easing policy in the Banks Quarterly Bulletin. www.bankofengland.co.uk/publications/ Documents/quarterlybulletin/qb110301.pdf
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Teams may vote on Bank Rate and the level of asset purchases.
Taking the MPCs current plan for asset purchases as its starting point, the team can decide to maintain or increase the stock of asset purchases, or to make asset sales. It is difficult to offer precise guidelines about how much money needs to be injected into or withdrawn from the economy to keep inflation on track to meet the target. Teams will have to judge whether they think the amount of money injected is appropriate given their views about the outlook for the economy and inflation, and how the extra money might impact on spending and, in turn, inflation.
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