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Quantitative Easing

Had we put together a list of what was least likely to happen in 2016, more quantitative easing would have featured prominently. It is just as well that we didn’t. Still, the Bank of England has deemed the outcome of the Referendum to be potentially so terrible that ‘things’ must be done. These things included a cut in interest rates (from almost nil to even closer to nil) and more quantitative easing. Early indications have been that the country is greatly heartened to learn that its quantities are going to be eased.

Quantitative easing is habitually snappily foreshortened to ‘QE’. Unusually for a financial acronym, QE is grammatically helpful. It is an easing of monetary conditions by the creation of a specific quantity of money.

It is widely accepted that the first incarnation of QE was in Japan in 2001. The western world has long been prone to mocking the Japanese: no growth, no inflation and no ideas. The West, we all knew, would never follow Japan. Never. They were different. They had a stock market bubble and years of deflation. My, how wrong we were. The Great Financial Crisis of 2007/09 saw the American Federal Reserve Bank start QE in early 2009, to be followed shortly afterwards by the Bank of England. It took Europe and the European Central Bank three years of denial and red tape before they too followed suit.

On the face of it, central banking is not an exacting task. The Banks have basically had one job to do – keep inflation near a target – and one tool with which to do it – interest rates. It really only starts to get interesting when the solitary available tool is not up to the job. Inflation is below target in many countries (for copious and contentious reasons), but what can Bankers do about this when their arsenal of interest rate cuts has run out of ammunition? They do not say ‘sorry, we’ve lost, over to you’. Oh no. They fire their secret QE weapon and predict inflation will return to target in a couple of years.

The process of money creation by QE is slightly convoluted. If we take the example of the UK, it all starts with the Bank of England buying gilts. It can do this because Central Banks can magic money out of thin air even more convincingly than Dynamo. They do this by giving the seller of the gilt a larger balance in their ordinary bank account. That’s what Central Bankers can do. Deposits are usually the main source of funding for high street banks and this newly enlarged balance can then be used to lend out. So if the Bank of England decides it will buy another £100bn worth of gilts, this increases the high street deposit base by the same amount.

Many believe QE to be a monetary medicinal compound, most efficacious in every case. Not only does it conjure new money out of thin air, it also lowers the yield on almost everything else as well. Lower yields mean that these assets are then cheaper to issue. More money, and cheaper. What could possibly go wrong?

Quantitative easing has come out of theoretical economics and into daily financial jargon. It is money printing with PR. And, like an unwelcome guest, it is here to stay.

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