For or Against Quantitative Easing

With their fiscal policy being so restrictive, the government seems to be relying on monetary tools to bring the economy out of recession. The low interest rates and the introduction of quantitative easing (QE) are clearly expansionary, with the aim of increasing demand in the economy.

I have previously explained the effect of the low interest rates, so I will explain the theory behind QE. It is often described as simply ‘printing more money’, but this is slightly misleading. QE is normally used when normal monetary policy fails to achieve the objectives of the Bank of England. It involves the Bank buying financial assets from banks and other private sector firms with electronically created money, thus increasing the excess reserves of the banks. The banks are then expected to lend more, so therefore increasing the amount of demand and consumption in the economy. Through the multiplier effect, the initial value of the QE is increased and should have a more imposing impact on the economy.

However as we know, the UK is still in a period of stagnation, showing that the monetary policies aren’t having the desired effect. This is most likely down to the conflicting fiscal policy that is aimed at reducing the budget deficit and is reducing demand in the economy further. There are also other reasons, such as the time lag that is expected from QE. So maybe it hasn’t been given enough time to take full effect and produce the results politicians are hoping for. The issue of time is also the reason that we cannot implement more QE, as the result could be a huge increase in the level of inflation as demand rises to too high a level. More QE will also lead to a lower exchange rate; this means imports become more expensive to buy. Here lies a problem as the UK has a high level of imports. The increased cost of imports would lead to an increase in the prices that we see, so affectively firms would be importing inflation.

The unpredictability of the level of increase in inflation is why some economists believe QE is not worth the risk. It could eventually lead to making the initial problem worse for the economy. In my personal opinion, QE is necessary considering the situation the UK is in and the lack of demand. It seems to be one of the only available options left to us, considering the Eurozone crisis and the world economy in general is also negatively affecting our economy.

Is the deficit that important?

I often hear on the radio or read in the newspaper that the government is aiming to reduce the national debt and this is the reason for the strict fiscal policies they are implementing. That is an incorrect statement. The government cannot be looking at reducing the national debt, since the UK has such a high deficit at the moment.

The deficit is the difference between how much the government spends and how much it collects on a yearly basis. Our national debt however, is the total amount we owe. So the deficit in fact adds to the amount of debt, we as a nation owe. The difference between the deficit and the debt is especially important because when politicians talk about reducing the deficit, all that really means is that our debt isn’t growing as fast. It does not mean we’re actually getting out of debt.

Reducing the deficit is such a major objective as it is growing at a faster rate than the economy. This means a rising debt to GDP ratio, which in the future could provide the country with a debt that is out of control. Obviously this presents a problem, as shown by the way Greece has been affected by its huge debt, which is resulting in an economic collapse.

The deficit has already been greatly reduced by this government, as it has fallen to 8.3% of GDP, but more needs to be done to reach the 3% figure. Reducing the deficit flags up a certain policy conflict, as the reduction in government spending also makes it much harder for the economy to recover and overcome this period of stagnation. I personally feel that the deficit is a slightly more important focus, because if it continued to stay at such high levels, the effects on the economy would be much more dramatic and damaging than if we stay in a recession for longer.