Mark Lamb | Sunday, 15 March 2009

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Quantitative easing

Weekly international investment round up to 13th March 2009

The ECB and the BOE’s interest rates now sit at historic lows

What is ‘Quantitative easing’ and does it work?

Just as the European Central Bank cut its base rate to a record low of 1.5% to stimulate the regions slowing economy the Bank of England reduced its rate for the sixth month in a row to just 0.50%, the lowest level since its formation back in 1694.
As financial stimulus weapons go, the Eurozone may still have a few rounds of ammunition left while the UK now seems to be engaged in hand-to-hand combat to stop its economy from being strangled to death and has announced plans to pump 75 billion sterling into the British economy. While rates may be falling one thing which increases is the use of financial buzzwords, get ready for the latest to be added to our growing list, ‘Quantitative Easing’ or ‘QE’.
The term refers to the creation of money by a central bank to increase the money supply and the availability of credit. ‘Quantitative’ refers to the fact that a specific quantity of money is being created and ‘easing’ refers to the reducing pressure on cash-strapped financial institutions.
QE is thought by many as the process of governments turning on their printing presses, printing more money and then pumping it into the economy. However, this isn’t strictly true just as when we ourselves buy a property we wouldn’t physically exchange huge bags of cash for the keys to our new home. In reality, the central bank electronically creates money and lends it out in return for collateral in the shape of financial assets such as government and corporate bonds. This should then help boost the system’s money supply as the institutions from which the central bank has purchased assets now has fresh cash available to use.
The situation faced by the Bank of England which led them to introduce this most vigorous QE process in central banking history is similar to that of a group of friends who, whilst in the middle of playing the popular board game Monopoly, suddenly have all their cash taken away. The players are left with assets on the board which no-one else can buy due to lack of available money together with the prospect of going around in ever decreasing circles. Simplistically, the Bank of England is acting as the ‘banker’ who has now pulled additional cash out of the box in order to get the game going again!
In reality, lying behind the BOE’s decision is the economic theory that the nominal growth rate of an economy can be no greater than the speed at which money is growing and flowing around the economy.
Was any other option available the UK? Just as QE is a direct method of pumping money into an economy the ‘helicopter drop’ is another. This would involve printing cash and distributing it directly to every family in the land and encouraging them to spend it.
Does QE work? Japan tried it in their ‘lost decade’ of the 1990’s with limited success as it was probably introduced too late. Ultimately, QE by the BOE is a bold step which others may soon find they need to follow.

Mark Lamb is Head of Life at Citadel Insurance plc which is authorised to carry on general and long term business of insurance under the Insurance Business Act, 19915 and is regulated by the MFSA. Contact by email; mlamb@citadelplc.com Tel; 25579000. Website; www.citadelplc.com
This article does not intend to give investment advice and its contents should not be construed as such. Information in this article has been obtained from various public sources and is given by way of information only. Readers are always encouraged to seek financial advice before making any investment decision.

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