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A new phrase to most of us, the term ‘Quantitative  Easing’ has been bandied around the last couple of months and equated to basically printing more money, which it kind of is really, but there is a bit more to it than that, so here’s some more explanatory info.

With no room to cut rates, to acheive it’s current aims the Bank of England must instead turn to more direct means of influencing the money supply. The nominal growth rate of an economy can be no greater than the speed at which money is growing, and flowing around the economy. This famous economic equation – the quantity theory of money – lies behind the Bank’s decision to create billions of pounds of new money.

Whether it will succeed is still the topic of much speculation, but Thursday’s announcement means it has thrown its weight behind this new policy of quantitative easing with more weight and vigour than any other central bank in history

THE BANK OF ENGLAND’S EMERGENCY WEAPONS

Buying company debt How does it work? The Bank buys, rather than lends against, the assets of private investors, be they pension funds, insurance groups or banks. The assets are most likely commercial paper (short-term company debt) and corporate bonds. It pays for the money from a pot of cash raised by the Government through issuing gilts – in other words without increasing the amount of cash in the system. This is what the Bank has attempted to do through the Asset Purchase Facility, and is what the Federal Reserve is doing in the US.

Pros If successful, it gets to the heart of the matter, reducing the cost of credit for companies and lubricating the capital markets for companies. Because the purchases are funded by the Government it is not particularly inflationary.

Cons It has proved very difficult for the Bank to get hold of the right type of commercial debt (in other words at a good price, and a type that won’t default). Pay too little and you will leave the taxpayer facing a big bill in the coming years.

Does it work? To an extent. The Fed has bought billions of dollars worth of corporate debt, but with little impact on commercial bond spreads.

Buying gilts (Government debt)

How does it work? The Bank buys government debt off investors and banks rather than corporate debt. This is something the Bank had authorised by the Treasury yesterday. The aim is to bring longer-term interest rates down, ensuring that companies and lenders cut their own rates.

Pros: Gilts are gilt-edged, and so have very little chance of defaulting (and if the UK Government has defaulted that is a whole other kettle of fish to worry about) and there are plenty of them around, so are easy to buy.

Cons: It does not make any direct difference to companies’ cost of borrowing, instead pushing down government interest rates: nice, but not the heart of the matter.

Does it work? Yes, if by that you mean getting long-term interest rates down. The Japanese did it in the past, but it has not yet been tried by the Fed.

Creating money to buy assets

How does it work? The Bank buys assets off private investors but funds those purchases by creating money (literally, with the push of a button; metaphorically, with printing presses). This is what the Government has now approved. The aim is to increase the amount of money in the economy, which will in turn increase either economic growth, inflation, or a combination of the two.

Pros: The UK faces a possible spate of debt deflation, and there are few more powerful weapons for a central bank to use than its printing presses. It can also aim to kill two birds with one stone and cut the cost of borrowing for companies by making cash more plentiful. With interest rates at zero, there are few other more powerful tools the Bank can employ.

Cons: In normal times, such a policy is potentially highly inflationary. There is every chance the Bank is unconsciously laying the ground for an uncontrollable wave of inflation in the future. Deflation is the big enemy at present but the threat may be overblown, and printing money – quantitative easing – will create a mess of unparalleled proportions to clear up afterwards.

Does it work? Yes and no. The only other time it has been used is by the Bank of Japan. As Japan is still trapped in stagnation, many say it failed. However, there is evidence the Japanese experience would have been worse had it not taken these measures. Some also argue that the BoJ was too slow to start quantitative easing.