What is quantitative easing?

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The background

When quantitative easing (QE) appeared on the British horizon in 2009, it was designed to help the Bank of England meet its inflation target.

The Bank had progressively slashed at the base rate, bringing it down from 5.25% in February 2008 to the current 0.5% level in March 2009.

The dramatic cuts were supposed to get banks lending again, to trigger consumer spending and help bring Britain out of the credit crunch. But the damage was too great and funds failed to flow.

When the Bank's Monetary Policy Committee (MPC) announced the historically low rate, it also unveiled plans to start injecting money directly into the economy as a form of stimulus.

This shifted monetary policy towards the quantity of money provided rather than its price but the objective - to meet the inflation target of 2% on the CPI (consumer price index) measure - remained the same.

If spending on goods and services remains low, then inflation will fall below its target. While too much inflation has a negative effect, falling inflation - known as 'disinflation' and 'deflation' - where the rate falls below 0%, can be equally damaging.

So the 2% target has been calibrated to help achieve economic stability and provide the right conditions for sustainable growth in output and employment.

Influencing the quantity of money directly is essentially a different means of reaching the same end.

The Bank expanded the amount of money in the system by £200 billion via quantitative easing.

How does QE work?

Contrary to what is often reported, QE does not involve the physical of printing money, so there are no printring presses rattling off millions of new notes.

However, extra cash is created electronically by the Bank which it then uses to buy assets such as government and corporate bonds.

The institutions selling those assets - which may include commercial banks or other financial businesses such as insurance companies - will then have 'new' money in their accounts, which then boosts the money supply.

This extra money supports more spending in the economy to bring future inflation back to the target.

Decreasing the supply of gilts also pushes up their price. This in turn sends the price of gilt yields down and as these determine long-term interest rates for overdrafts, some fixed-rate mortgage products and most business lending, there is an added advantage.

Where has QE been used?

It may not have been common parlance for long, but QE has been around for almost 80 years, having first been tried by the US Federal Reserve in 1932 when it purchased $1 billion (c£645.9 million in today's money) in securities and continued to buy gilts and gold for several years after.

Fast forward 76 years and the Fed dusted off QE and announced plans to purchase up to approximately $1.7 trillion of agency debt, agency-guaranteed mortgage-backed securities, and Treasury securities. The US Treasury collaborated, buying for its own account approximately $220 billion in agency mortgage-backed securities during 2009.

QE had already been used in Japan by that time though, as the government there deployed it - unsuccessfully - in 2001 to fight deflation after an extended period of interest rates sitting at close to zero. It was also a key tool for Japan in 2010 and 2011.

QE had never been tried in the UK before the BoE's foray in 2009. Analysts remain divided over whether it works.

The UK was the last major economy to come out of recession and its growth rate was initially very slow, while lending remains depressed. But we can never know what would have happened without QE.