Monday, November 15, 2010

QE2

The QE2, you may believe, is a cruise liner, but you'd be wrong. It's what hip and happening economists are calling the second bout of Quantitative Easing by central banks around the world. Well, by the US Central Bank, the Federal Reserve, at any rate. Relatively strong UK economic growth last quarter meant the Bank of England decided against QE2 at its last MPC meeting.

Quantitative easing is, in very simple and not overly accurate terms, the printing of money by central banks. Its official name in the US is the "large-scale asset purchase plan": It is the central bank buying huge amounts of financial assets (bonds and bills) on financial markets, the result being that they push money into the economy (since they have to use money to buy these assets).

The hopeful idea is that this enables the economy to grow because there is more money going around for people to use; one of the common themes of commentators on the state of the global economy has been that no money is available for investing as banks repair their balance sheets.

One way which we'll learn about next term that Central Banks influence economic activity is through interest rates. Lower interest rates make current use of money cheaper (credit is cheaper, less opportunity cost related to saving) and hence this is a common policy used for helping economies escape recessions. However, once interest rates reach zero then Central Banks cannot reduce them any lower to stimulate economic activity, and hence why some central banks have resorted to QE: It is an alternative way to make more money available more cheaply.

As may not be totally unsurprising given the current political climate in America, opinions are strongly divided about QE2. Some argue it's essential to stimulate economic growth in the circumstances, but others are worried about it, not least Sarah Palin.

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