Nov 5, 2020

News | Business | UK Economy: What is quantitative easing and how will it affect you?

 

Ben King



Shoppers in Portsmouthimage copyrightAFP

image captionQuantitative easing aims to support the economy by encouraging people to save less and spend a bit more

The coronavirus pandemic has been a massive blow to the economy, hitting jobs and businesses hard. The Bank of England is to pump another £150bn into the UK economy to help it recover, in another round of "quantitative easing".

What is quantitative easing meant to do?

When economic times are hard, people worry about losing their jobs, and grow wary about spending money. Businesses see their customers staying away. They start losing money, and may have to lay off workers.

Normally, the Bank of England would try to make things better by cutting interest rates.

Lower rates mean you get less interest on your savings, so it's less attractive to save money than to spend it. And lower interest rates make it cheaper to borrow money, so it's easier to buy a new house, or car, or expand your business.

People buying things and businesses investing helps the economy stay healthy, protecting jobs.

But interest rates are currently just above zero - there's no scope for another big cut.

That's why the Bank has turned to quantitative easing (QE). It's another way to encourage spending and investment.

Bank of Englandimage copyrightGetty Images

How does QE work?

The Bank of England is in charge of the UK's money supply - how much money is in circulation in the economy.

That means it can create new money electronically. That's why QE is sometimes described as "printing money", but in fact no new physical bank notes are created.

The Bank spends most of this money buying government bonds.

Government bonds are a type of investment where you lend money to the government. In return, it promises to pay back a certain sum of money in the future, as well as interest in the meantime.

Buying billions of pounds' worth of bonds pushes the price up: when demand for anything increases, the price usually goes up too.

Many interest rates on loans offered by banks to businesses and individuals are affected by the price of government bonds.

If those government bond prices go up, the interest rates on those loans should go down - making it easier for people to borrow and spend money.

Houses

image captionWill more QE make it easier to find a mortgage?

In addition, many investors buy government bonds in times of crisis, as a safe place to put their money, because the UK government has never failed to repay a bond.

If the Bank of England drives the price of those bonds up, that safety becomes more expensive.

So those investors may be encouraged to buy shares or lend money to businesses again instead - both of which will help to support the economy.

Has it happened before?

The first QE programme in the UK was launched in 2009 when the financial crisis was threatening the economy, unemployment was rising and the stock markets were in freefall.

The Bank subsequently launched new rounds of QE after the eurozone debt crisis, the Brexit referendum and the coronavirus pandemic.

QE graphic

A number of other countries started QE programmes after 2009, including the US, the eurozone and Japan.

Does QE help fund the fight against Covid-19?

The government will spend well over £300bn on fighting the coronavirus pandemic this year, on measures such as the furlough scheme, support for business and extra funding for the NHS.

That means it has to borrow hundreds of billions of pounds, which it does by issuing bonds.

The fact that at the same time the Bank of England is buying hundreds of billions of pounds' worth of bonds helps the government to raise that money.

The Bank doesn't buy directly from the government, it buys from other investors, but its actions undoubtedly make government borrowing cheaper and easier.

When the latest round of QE is complete, the Bank of England will hold well over a third of the national debt.

The government also pays much less interest on bonds owned by the Bank of England than other investors - which takes further pressure off the public finances.

What was the impact of QE?

Most research suggests that QE helped to keep economic growth stronger, wages higher, and unemployment lower than they would otherwise have been.

However, QE does have some complicated consequences.

As well as bonds, it increases the prices of things such as shares and property. This tends to benefit wealthier members of society who already own these things, as the Bank itself concluded in 2012.

Meanwhile, younger people found it harder to buy their first homes and build up savings.

Was it bad for pension funds?

Another important side effect of QE hit pension funds. Government bond prices are used to estimate how much it will cost to provide pensions in the future.

If those bond prices go up, the cost of providing future pensions rises. As a result many firms were obliged to make bigger payments into their pension schemes, reducing money available to invest elsewhere.

And in many cases, QE will have contributed to the decision to close pension schemes altogether.

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