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

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  • rate this

    Comment number 1.

    aren't we at the point where a bit of inflation would be good for more or less all of us. . . . how else do we stir Keynes's 'animal spirits' when this government is doing all it can to remove all sources of demand from the economy. . . .

  • rate this

    Comment number 2.

    There is not a shred of evidence to show how QE has a proportionate effect on the UK economy.
    There are no accounts whatsoever that any member of the public can review relating to this money
    The use & application of this money is totally unaccountable & non-transparent
    QE is a device for enabling over-paid incompetent fools, to move large amounts of public money & pretend they are big money men

  • rate this

    Comment number 3.

    Look at those stock markets go... The bankers will be so happy that they are going to get more big bonuses this year.

    The UK is now no different from Zimbabwe and Germany in the 1920's. Printing money to pay off it's debt. Should be illegal but, hey, we're from the West so no-one is going to send us to prison.

  • rate this

    Comment number 4.

    Absolutely certain that Mervyn King will see it differently - he is a politician - and the last politician to tell the truth was Abe Lincoln.

  • rate this

    Comment number 5.

    Think this one through - QE soaks up existing assets and pumps new money into the system in their place. Where will the new liquidity go? Clearly it's not being lent to businesses or for mortgages - some may go into rebuilding balance sheets - but where does the rest go? Follow the money - where's the activity? Commodity & other types of speculation are the big areas - making inflation worse.


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