Q&A: How will quantitative easing affect me?

From Times Online
March 5, 2009

Q&A: How will quantitative easing affect me?

David Budworth

The Bank of England voted today to begin quantitative easing — effectively printing money — to drag the UK out of recession. Here we explain how this radical decision could impact on your finances in the months and years to come.

Q: Who is going to benefit directly from the extra money printed?

A: Banks, other big institutional investors and possibly large companies, but not the average person.

When a central bank like the Bank of England embarks on quantitative easing it has to find a way of pumping the extra money created into the economy. The Bank is expected to offer to buy government bonds, called gilts, from institutional investors and the corporate treasury departments of large companies using the billions created. It might also offer to buy corporate bonds from the same investors but private individuals will not be part of the buy-back programme.

Q: How will this cash makes its way into the wider economy?

A: The investors who get their hands on the money are expected to deposit this cash in the banking system, helping to boost bank reserves.

Q: If banks have more money in their coffers, will it become easier to borrow money?

A: Anxious banks are still reluctant to lend money to individuals and businesses despite historically low rates. However, if quantitative easing works, it will become easier to take out a mortgage or loan and here is how it could work.

Quantitative easing will flood the UK banks with hard cash, but because the base rate is only 0.5 per cent they will earn hardly anything by sitting on that money.

Hopefully this will persuade the banks that it will be more profitable to lend the money out, ending the lending freeze that has crippled the economy and exacerbated the house price slump.

Q: What will that mean for economic growth?

A: If households and businesses are able to borrow more, they will have extra money in their pockets. This should increase spending helping to stimulate economic growth, boost employment prospects and even drag us out of recession.

Q: Will it work?

A: No one can be sure.

Ian Kernohan, the chief economist at Royal London Asset Management, said: "It is still not clear why banks have been so anxious about lending. If it is because they haven't had access to enough funds then it could work. But if they are worried about lending at a time when we are in recession and house prices are falling they may not want to boost lending."

There is a danger that the banks will simply sit on the money rather than increase lending.This is what happened in Japan at the early part of this decade. Because the money wasn't dispersed into the wider economy Japan suffered from a long-term recession.

Q: How long will it be before we know if it has worked?

A: Months not weeks.

Q: Are there any downsides to central banks creating money through quantitative easing?

A: There is a risk that the extra money will encourage too much growth and ignite inflation. The Bank could then have to raise interest rates aggresively.

However, it could be several years before this becomes apparent as deflation — falling prices — is the most serious risk in today's environment. And if the Bank makes the right decisions in the coming months it should be able to control inflation before it gets out of hand.

Q: Isn't the Bank of England being reckless by encouraging more borrowing?

A: Reckless lending sparked the financial crisis, but most economists think that we have gone too far in the other direction and are not borrowing enough to keep the economy running smoothly.

Kernohan said: "We have gone from feast to famine and need to get back to a more normal situation where businesses and individuals can have access to credit. At the moment we are in a vicious circle and the bank is aiming to change that into a virtuous circle."

Q: Will I be affected if I am invested in gilts?

A: Martin Gahbauer, a senior economist at Nationwide Building Society, said: "In the short term, this could push gilt yields down. Yields have already fallen quite significantly in expectation that the Bank was going to do this."

Bond yields are one of the main influences on annuity rates so this could be bad news for those approaching retirement.


http://www.timesonline.co.uk/tol/money/property_and_mortgages/article5851508.ece


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