The meaning of QE2

 

If you're not sure of the quality of your ammunition, it's best to fire first. Some will see that as the explanation for the slightly early launch of QE2 from the Bank of England today.

Even a week ago, the betting was that the Bank would hold fire this month. Senior Bank officials have always said they would need a good reason to press the button on more money creation - that good reason being that the UK was at risk of a prolonged period of economic weakness, not a "soft patch" which might force them to reverse the policy in a few month's time.

Unfortunately, the events of the past few weeks appear to have given them that reason. They didn't need to see it in black and white, in the new quarterly forecasts that will be completed for next month's meeting.

Yesterday's GDP figures - and the mood music in the eurozone over the past week - probably sealed the deal. There is an explicit reference, in the statement, to the economy having more spare capacity - for a longer period - than previously thought.

Some say QE distorts the economy - and pushes up inflation - without doing much to increase real economic activity (more technically, it raises the cash value of GDP, but not necessarily the real volume of output.)

In a recent study, the Bank of England disagreed: it reckoned that that creating £200bn as part of QE had raised real GDP by 1.5-2%, while increasing inflation by 0.75-1.5%. If this additional £75bn works in a similar way, you could say today's move would have a roughly similar impact to maybe a 0.5-1 percentage point cut in the base rate.

Or that's the theory. In the City these Bank estimates of the impact of QE are considered pretty generous, at least when it comes to real output.

Some say that QE is all a confidence trick - albeit, an important one. What, exactly, the Bank does is less important than the fact that it is seen to be doing something.

The US comedian, Mitch Hedberg, had a line I reprised on the Today programme this morning: "My fake flowers died, because I forgot to pretend to water them."

There's something of that in the city's support for QE2. It may not do a huge amount of good, but it could seriously hit confidence if the Bank seemed to have nothing left to throw at the recovery.

On this view, the Bank needs to pretend to water the economy, even if there's less and less chance of it doing any good.

I will be interviewing Mervyn King this afternoon. I have a funny feeling he will see it differently.

 
Stephanie Flanders Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this
    0

    Comment number 137.

    If QE is used to buy assets whose value declines then the Taxpayer will have to fund the difference through greater future taxes. At what point does QE become another form of public spending?

  • rate this
    0

    Comment number 136.

    I believe banks will either sit on cash or spend in Asia therefore QE protects banks and/or pushes up inflation. I don't see how QE can work effectively if government isn't willing to take on debt.

  • rate this
    +1

    Comment number 135.

    We have to get the economy spending again, unfortunately lowering interest rates has not worked. The theory behind QE is sound, but I am not convinced it works! The banks hold onto too much of the funds and don't let it filter down to the consumer or small business' where it is needed. Its a difficult situation to be in and it wont improve until the Eurozone cleans its act up. Confidence has gone

  • rate this
    0

    Comment number 134.

    QE3 instantly dropped the £'s value against 16 major currencies by 1%

    All imports and commodities in those currences (Oil, Gold, Food) will instantly increase by 1%+

    A calculation of GDP on a bit of paper will rise, the media cannot report the UK is in recession.

    We will have to pay this money back, this is a crime against the prudent and a saviour for the profligate.

    Sack them all

  • rate this
    0

    Comment number 133.

    A small percentage of this QE2 figure given to Local Authorities across the nation, ring fenced and used to build low-rent housing on council owned brownfield land would have a much greater impact on the wider economy and crucially would be perceived by the wider population as a step forward.

 

Comments 5 of 137

 

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