If you live in a country where there is unemployment, the banks are not lending and consumers are not spending money, resulting in a slowdown of the economy, then you must have noticed that the country’s Central Bank resorts to what is called Quantitative Easing (QE).  In the UK, the Central Bank is the Bank of England, while in the US this is the Federal Reserve. 

Quantitative Easing is when the Central Bank buys bonds from banks, insurance companies or pension funds in order to boost the economy in times when traditional economic strategies don’t work. It does so by creating electronic money which it gives to banks by buying their bonds. The aim is to encourage them to loan the new money to people and companies, who will then go out and spend it, stimulating the economy.

A bond is issued by a government or corporation, called the issuer. When someone buys a bond they are lending money to the issuer who promises to make future payments. As a signed IOU, the bond can then be exchanged in the secondary market. In this case, the two parties are trading a debt, but unless, the issuer pays the original debt, the bond will continue circulating in the market until it matures and the loaned funds have to be returned. 

In the UK, bonds are called gilts and in the US, securities. Gilts are issued by the UK government and are UK debt. The UK national debt is all the money the government owes to those private companies which bought UK gilts.

Now, knowing that a gilt is only government debt, you will start wondering how beneficial QE is for the UK economy or its people. In effect, the BoE is buying government debt which it trades in the market with banks. What we have here is Paul and Peter exchanging debt or borrowed money. Very often, these banks avoid risking their new funds and, instead of lending it to businesses and consumers, they prefer to save it.

Condition: QE will work if the banks lend money to you and me.

But let’s see how QE is supposed to work:

1. The Central Bank of a country creates electronic money.

2. This new money is used to buy bonds from financial institutions (banks, insurance companies, pension funds, or investment banks).

3. This causes interest rates to fall.

4. Banks’ funds increase by selling their bonds to the Central Bank.

5. Because of the low interest rates and extra funds, the banks increase their loans.

6. Consumers and businesses take advantage of low interest rates and increase spending or lending, respectively.

7. The increase of the consumers’ disposable income (after taxes and social insurance are deducted) will increase economic activity and cause the economy to grow.

Consequences:

1. The increase of money devaluates the country’s currency in relation to that of other countries. It weakens the currency’s exchange rate.

2. Lower interest rates cause cash to flow outside the country, diminishing foreign demand for the currency, and weakening the currency.

3. QE is beneficial to exports and those who owe money, since with lower interest rates, there are lower debts.

4. But this is damaging to imports, since imported commodities become more expensive and creditors receive less income from interest.

5. Wealthy people who own stocks in big corporations (and thus can get a part of the corporation’s earnings), like QE because it boosts their stocks’ value.

6. Pensioners and savers are losers because with low interest rates they get less money into their savings.

7. In the end, usually, the Central Bank is pumping more money into banks and investment companies, which instead of lending it to consumers or investing it to new businesses, they keep it, increasing their wealth. In the case, that they invest it abroad, they cause those countries’ currencies to go up, making their exports less competitive. In other cases, they proceed to buy back the same bonds creating bubbles. A bubble is created when suddenly many investors buy bonds, increasing their value and when they no longer want to buy in such high prices, they cause the bubble to burst.

For example, the Professor of Economics and former Minister of Finance in Greece, Yanis Varoufakis, when discussing the British and American experience with QE, said that is “ineffective” compared to the amount of effort and cost. By buying paper assets, which have nothing to do with real people and their money, “the result is to reflate bubbles that are better left deflated, in the hope that the money made by those fortunate enough to benefit from these bubbles will trickle down to the rest of the social economy.” He also added that in Britain QE “failed to turn idle cash into productive investments” that can create “meaningful jobs that produce meaningful goods and services.” 

In the end, QE keeps the global system unchanged by supporting the liquidity of banks. They accumulate more money but ordinary consumers continue to struggle and don’t feel any benefit.