The policy of Asset Purchases by a Central Bank is usually known as ‘Quantitative Easing’.
We first saw QE in 2000 in Japan when the central bank used it to combat deflation.
The US Fed followed suit in 2008 and the UK in 2009.
Europe is yet to get involved but many think that is only a matter of time as deflation looms.
What does it entail?
Quantitative Easing does not mean printing more bank notes. It’s not about giving money to banks. It’s about circumventing the banking system.
The BofE electronically creates new money and uses it to buy gilts from investors like pension funds and insurance companies.
These investors typically do not want to hold on to cash as it yields a low return. So they tend to use it to purchase other assets, such as corporate bonds and shares.
This in turn lowers longer-term borrowing costs and encourages companies to issue new equities and bonds.
That, it turn, stimulates spending and helps keep inflation on track to meet the Government’s target.
Why are we seeing so much of it?
In March 2009, the BofE Monetary Policy Committee (MPC) announced that it would reduce the base rate to 0.5%.
They also judged that it could not practically reduce the rate below that level.
As they wanted to stimulate the economy, they decided to undertake a series of asset purchases.
Between March and November 2009, the MPC authorised the purchase of £200 billion worth of assets, mostly UK Government debt or “gilts”.
What’s the objective?
The purpose of the purchases was and is to inject money directly into the economy in order to boost demand.
Despite these different means of implementing monetary policy, the objective remained unchanged – to meet the CPI target of 2%.
Without that extra spending in the economy, the MPC thought that inflation would be more likely in the medium term to undershoot the target.
When interest rates are already low, QE is a way for central banks to boost the economy and avoid deflation.
Money is released, lent and spent.
On the flip side, critics say lending to businesses and individuals remains sluggish.
There’s no guarantee the proceeds of any asset sales are used to invest or lend, and indeed many banks have simply used QE to help strengthen their balance sheets.
The reality is that we can never know what state the UK or other economies would have been in following the financial crisis without the QE measures.
QE impact is difficult to measure – it’s not immediate or direct and at the same time the economy is influenced by other drivers.
Sources: http://www.lifeoutlined.co.uk/moneyplus-blog/quantitative-easing-demystifying-qe/