QE 101: What is Quantitative Easing?

The term Quantitative Easing (QE) is not only hard to say, but it can be a bit of a tricky concept to grasp. It sounds so much like technical jargon that many people –  journalists, policy-makers and even economists – are completely put off by it.

But at the same time, the UK’s QE programme involves such a large sum of money –  £445 billion! More worryingly, its general effectiveness is questionable, and its negative side effects so significant, that it’s not something we can afford to turn a blind-eye to.

At Positive Money, our aim is to create more awareness about QE, in order to get everyday people to feel empowered enough to talk about it. Therefore, we are launching a QE 101 series in order to explain it in very simple (jargon-free) terms, so that anyone interested can wrap their heads around it.

The Story of Quantitative Easing

When policy-makers are concerned about the state of the economy and worried that there isn’t going to be enough spending and investment to trigger growth, they have different tools available to stimulate economic activity. One of the main tools is the Bank of England’s interest rate policy.

By lowering interest rates the Bank of England encourages people and companies to spend and invest rather than save. Lower interest rates also make bank loans cheaper, which should incentivize people and businesses to borrow, and consequently, spend and invest more.

At a very basic level, when there is more spending and investment in the economy, businesses make more profits, so they hire more people. With more people employed and on a monthly salary, there are more people spending, which leads to businesses making more profits, more businesses hiring and investing, more people employed and spending, etc.

After the 2008 financial crisis struck, the recession was so severe that the Bank of England continuously lowered interest rates – until they almost reached zero. But, because households and businesses had taken on so much debt in the run-up to the crisis, they really couldn’t afford to take on any more loans.

Meanwhile, businesses and households that could afford to take out loans were so worried about the state of the economy – that it made little sense to take out new loans. At the same time, banks had made too many risky loans prior to 2008, and they were not keen on lending more.

Therefore, even with interest rates close to zero, the Bank of England’s monetary policy had failed at triggering a recovery in spending and investment. The Bank of England therefore needed to adopt a different, more unconventional approach – Quantitative Easing (QE).

What is Quantitative Easing?

QE is where central banks, such as the Bank of England, create new money out of nothing to buy financial assets (economic jargon for government and corporate debt in the form of bonds) from financial entities such as pension funds, insurance companies and investment banks, etc.

In the media, QE is presented as a process whereby the Bank of England prints money and lends this to banks so that they can increase their lending into the economy. But in reality, no actual physical cash is ever printed and most people (let alone banks) don’t ever see the money created via QE.

What actually happens is the Bank of England creates new digital money, central bank reserves, which are then used to predominantly buy government debt (and more recently corporate debt). From 2009 to 2012, the Bank of England created £375 billion of new money.

This programme is still on-going. In fact, more recently the Bank of England announced that it would be expanding the programme by another £70 billion, bringing the total to £445 billion. Concerned that investment and spending might drop due to the Brexit vote, the Bank of England will purchase another £60 billion worth of government debt, and £10 billion worth of corporate debt.

The Aim of QE

The effectiveness of QE is extremely controversial. Indeed, our position is that it does more harm than good – and there are much better alternatives, but we are getting ahead of ourselves here. In our next post, we go into more detail on the theory behind QE, and in later posts, we show how QE doesn’t work in practice – and instead leads to more financial instability and inequality, as well as higher house prices.

For now, it’s worth noting that QE is supposed to increase the price of financial assets, making assets holders feel wealthier – encouraging them to spend more (the so-called trickle-down effect). It’s also intended to lower interest rates in financial markets. This means lower borrowing costs, encouraging businesses to issue more debt to finance investment.

Low interest rates mean low returns for investors, and theoretically should encourage them to look for riskier, higher yielding investments. Finally, pension funds and insurance companies should buy riskier assets to replace the ones they sold to the Bank of England, all of which is intended to redirect credit and investment to businesses.