Quantitative Easing - Will It Revive The Economy

The Bank of England further reduced the Base Rate to 0.5%. This is the lowest it has ever been but what is the next step to take as there doesn't seem to be much manoeuvring space left? This is where the monetary policy of quantitative easing comes in, in an attempt to ease the already flagging economy.

What is Quantitative Easing?

In its simplest definition, quantitative easing is described as 'printing money', although these days the money does not literally have to be printed but is created electronically. Quantitative easing works by using money that has basically been created out of thin air to to things like buying assets such as government bonds and corporate bonds. Also the money is loaned to other banks by the Bank of England or used to buy other banks' assets.

The theory is that these institutions will then have more money, which in turn should boost the amount of money in the economy, as they should be more willing to lend to other banks and individuals.

Why use quantitative easing?

Since the credit crunch hit, banks have been over-cautious with their finances and as such they have tightened up their lending substantially. This in itself has had a severe knock-on effect for businesses that then find it difficult to borrow from these banks, so the amount of activity in the economy decreases.

Reducing interest rates was the Bank of England's way of trying to increase the amount of money in the economy. The reduced rates should have resulted in people having more money to spend. However the rate has been reduced to as far as it can go so another measure is being attempted. Also the reduced interest rates did not help everyone, like those on a fixed rate mortgage.

Will quantitative easing work?

As the economy is very much in unknown territory, it is difficult to know how this monetary policy will work out. The outcome very much depends on what the banks do with the money and how much they hold on to rather than lend out. The hope is that they will increase their lending to businesses and individuals, resulting in an increase in activity in the economy - what many economists agree needs to happen for any kind of recovery to begin.

However quantitative easing is viewed as a high risk strategy and if not done right, banks may still be reluctant to lend.