What is quantitative easing, how does it work and why does the Bank of England use it? Business

If you need 150 billion pounds in a hurry, printing it out is probably the fastest way to get it.

One of the main tools the Bank of England can use to influence the economy is quantitative easing (QE). We often talk about money printing, even if nowadays everything is done digitally.

When the Bank of England announced it would inject an additional £ 150bn into the UK economy, bringing overall spending to £ 895bn, it was talking about expanding its QE program.

What is quantitative easing?

Quantitative Easing is one of the main ways central banks can support their economies, and it is essentially a way to create money. In a crisis, the big banks lend less, but at the same time, people continue to repay the loans, which reduces the amount of active currency in the economy. QE is a way to create money when banks don’t.

This process is done digitally, and central banks then use the new currency to buy things that will strengthen the purchasing power of the economy.

Government bonds are the most common thing for spending money on QE.

What are government bonds?

This is because government bonds are an investment in which the central bank lends the government a sum of money for an agreed period, plus interest.

By spending billions on these bonds, the price of these bonds goes up because suddenly they are more popular: it’s just supply and demand. When the price of a bond goes up, the interest rate goes down – it’s a mechanical link between the price and the rate. This means that it becomes cheaper for the government to borrow.

Government bonds are an integral part of the financial system and are generally considered the closest solution to a “risk free” asset. As a result, the prices of government bonds influence other financial instruments, such as bank interest rates on loans to individuals and businesses. Lower interest rates in turn allow people to borrow money and therefore spend it, which in turn stimulates the economy.

While borrowers benefit, the opposite is true for lenders. QE also reduces the return (interest) that investors can expect on these government bonds, due to their popularity: they are more expensive to buy and offer less interest because many people want them.

This means that if investors want a higher return, they should consider taking more risk. Instead of government bonds, they can put their money in corporate bonds, or in stocks, or lend it to others, putting that money into active circulation in the economy.

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This notice was published: 2020-11-05 15:18:45