Having looked at interest rates, it is now time to look at the other half of monetary policy – quantitative easing. This is only used when the economy is severely struggling, and is a much more blunt instrument compared to interest rates, as we will see in this article.
Quantitative easing is controlled by the Bank of England’s MPC, or Monetary Policy Committee. It involves the Bank creating money digitally, which is used to buy assets in the financial market, usually in the form of government bonds (or gilts). This is done on the scale of billions of £s, and so this massive injection of money into the economy has very large, widespread and resonant impacts.
Its main objective is to boost spending and stimulate economic growth, as there will be more money circulating the economy through the circular flow of income. This means people have more cash that they can use to buy more goods, which allow firms to gain more profit and invest more, and hire more worker, who can go on to spend this additional income – essentially, the multiplier takes effect. This increases AD many times over, thus increasing the rate of economic growth, one of the key macroeconomic objectives.
Another positive effect of quantitative easing is a depreciation in the exchange rate. The creation and release of this enormous quantity of digital currency increses the supply of the £, decreasing the exchange rate due to an outwards shift in supply on the exchange rate diagram, as seen below. This makes exports cheaper and more competitive while making imports more expensive, increasing net trade. This reduces the current account deficit, another macroeconomic objective, and increases AD which can lead to increased output.
However, one disadvantage of using quantitative easing is inflation. If everyone suddenly has more cash, they would go out and try to spend it. For a while, people are able to sustain a higher standard of living, but eventually the sudden addition of money means there are more £s chasing the same goods, which bids up the prices. This leaves real income the same, if not worse, compared to before the policy was implemented, alongside massive inflationary pressure.
Leave a Reply