British central bank turns to radical ‘quantitative easing’

LONDON – The Bank of England launched a ‘quantitative easing’ policy yesterday to pump new money into the economy, using a radical route to break the credit crunch, stimulate bank lending and fight recession.

With interest rates close to zero, central banks have to turn to other tools to manage monetary policy. Under quantitative easing, they create money to boost the money supply and prevent prices from falling into a trend of deflation.
Central banks use new money to purchase assets, such as government bonds and commercial paper, in a move frequently referred to as printing money.
The unconventional measure is currently being considered by the US Federal Reserve, and was adopted by the Bank of Japan in 2001.
The central bank has monopoly control of overall creation of money. The new cash is created electronically, but the process has much the same effect as printing notes because it expands money supplies and boosts the balance sheets of banks and institutions.
The BoE, which also slashed interest rates to 0,5 per cent yesterday, said that it would create 75 billion pounds (106 billion dollars, 84 billion euros) in the next three months to buy up government bonds from commercial banks.
The British government has authorised the central bank to create as much as 150 billion pounds in new money to buy up such assets.
The plan does not breach EU regulations because quantitative easing will be used as a tool of monetary policy – and not to finance a public deficit.
Quantitative easing can fail if banks refuse to lend more cash despite the increase in liquidity. And if too much money is pumped into the economy, it can spark rocketing inflation.
Since the credit crunch erupted in 2007, commercial banks have become extremely reluctant to lend cash amid fears about their exposure to the collapsed US subprime property market and the ensuing global financial crisis.
In response, the Bank of England has slashed its key lending rate since October in a bid to break the credit crunch and boost Britain’s economy, which was dragged into an official recession in the second half of 2008.
The Bank of Japan adopted quantitative easing in 2001 as the country battled a decade-long inflationary spiral.
But analysts remain uncertain about whether the BoE plan will work.
‘The BoE is clearly acting far more aggressively than most other central banks although it is far from clear how successful this new strategy will be,’ said Derek Halpenny, economist at The Bank of Tokyo-Mitsubishi UFJ in London.
‘The one clear example is Japan which purchased huge quantities of short-term bills that resulted in excess reserves reaching 35 trillion yen.
‘However, the appetite to lend these excess funds was not there and the policy largely failed.’
But the BoE’s plan could complement other British policies aimed at fixing the troubled financial sector.
‘There are grounds for believing the prospects are better for the UK, given the aggressive policies already implemented to restore financial sector confidence,’ Halpenny added.
Edward Menashy, chief economist at Charles Stanley stockbrokers, agreed that Britain now had an ‘excellent chance’ of beating the credit crunch.
‘With reduced interest rates proving ineffective, the (BoE) has decided to go down the path of quantitative easing,’ Menashy said.
‘Given the reconstruction already undertaken in the banking sector regarding recapitalisation, the ring-fencing of toxic assets and the insuring of other debt, this combined with quantitative easing should give the UK an excellent chance of overcoming the credit crunch.’
– Nampa-AFP