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QE too?

Yesterday, the US Federal Reserve announced that it was introducing its second round of quantitative easing, by pumping $600bn (£373bn) into its economy by the end of June 2011.

Will the Monetary Policy Committee of the Bank of England follow suit? The answer for the meantime is ‘no’. Today they decided to keep interest rates on hold at 0.5% for the 20th month in a row, and not to increase quantitative easing.

There is a difference between the Bank of England and the Federal Reserve. Technically, the BofE is only given the brief of keeping inflation within one percentage point either side of 2%. However, the Fed is tasked with the twin roles of promoting a high level of employment and low, stable inflation.

The US is particularly concerned about the rate of job losses. Unemployment currently stands at 9.6% and 95,000 jobs were lost in September alone, largely because public sector cutbacks were larger than private sector hirings. Sound familiar? On top of this the economy is only growing at an annualised rate of 2%, which does not seem sufficient to reduce unemployment.

The Fed is injecting $600bn into the US economy, whilst the Bank of England continues to play a waiting game.


As the Fed said the “pace of recovery in output and employment remains slow. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth and tight credit.”

Ben Bernanke, chairman of the Federal Reserve Board of Governors explained the reasoning for the second dose of QE in an article in The Washington Post today. He cited the fact that underlying inflation is running below 2% and could easily “morph into deflation (falling prices and wages), which can contribute to long periods of stagnation.”

He pointed out that low inflation levels indicate considerable spare capacity within the economy, which means that monetary policy can be used in this way to support additional employment without risking overheating of the economy. Given that short-term interest rates are about as low as they can go, the additional QE will involve the purchase of longer-term securities.

The initial response to this move by the Fed was that stock prices rose and long-term interest rates fell. Bernanke claimed: “Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

There have been some criticisms of QE, and some commentators wonder whether lower long-term interest rates alone will be sufficient incentive to companies to invest. There is always the possibility that they may use cheaper loans to buy back shares rather than undertaking capital investment.

Bernanke tried to defuse some of the criticisms by saying that although some critics had voiced concerns that QE would lead to excessive increases in the money supply and eventually inflation, this had not happened in the previous round of QE. He said that there had been little effect on the amount of currency in circulation or on other broad measures of money and it did not result in higher inflation.

The difference between the UK and the US, at the moment, is that the UK has a stubbornly high level of inflation, with CPI currently at 3.1%. However, if economic growth falters over the next quarter or two, then the MPC may well feel that it will be a case of more QE too.

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Posted in Bank of England, Consumer Price Index, Deflation, Inflation, macroeconomic policy, Monetary Policy Committee, Money Supply, US economy

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