0115 966 7955 Today's Opening Times 10:00 - 20:00 (BST)

Quantitative Easing: Impacts and Risks

Published: Last Edited:

Disclaimer: This essay has been submitted by a student. This is not an example of the work written by our professional essay writers. You can view samples of our professional work here.

Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UK Essays.


The Financial crisis of 2008-09 submerged the governments and central banks globally, financial crisis affected trades all over the world.

During the earlier economic slowdown, traditional tools were used such has regulation of fiscal policy, setting the low interest rate on short term government debt. Equilibrium in the money market is achieved by changes in interest rate (John Solman, p621). But even after reducing the interest rate to nearly zero per cent, UK and US had to adopt a new tool of monetary policy named as "Quantitative easing" which has not been used in the past by them (Dean Drysdale, 2010). The term Quantitative easing was introduced by central bank of Japan during 2001 crisis. However, this policy did not help japans' economy much and the growth remained stagnant. (Shirakawa Masaaki, 2002).

Quantitative easing increases the money supply in the system by monetizing [1] the debt (Dean Drysdale, 2010). By using QE to take economy out of deflation might risk getting it into the high inflation. QE needs to be monitored and regulated. UK and USA are using QE on massive scales. Thisreport highlights the impact of the quantitative policy taken by Bank of England on UK Economy and effect on the global trade.


Quantitative easing is the monetary tool used by central bank to stimulate the economy. It is an economic tool used to eradicate the stagnation in the economy by injecting money into it. Central banks lower the interest rates to encourage people to spend but when the interest rate cannot be lowered any further then central bank has to inject money in to the economy to increase the trade and flow of the money in the system(bbc.com, 2010).

Equation of exchange or also known as quantity theory of money shows the relation between aggregate demand, money and GDP. According to the theory, MV = PT. Where M is the money in the economy, V is the speed with which money flows around the economy. P is the price level and T is the GDP or value of transactions. Quantitative easing aims to increase the T i.e. the number of transaction in the system by increasing the money. It also implies that if inflation has to be controlled it should be done by controlling money supply (John Solman, p 630)

If injection of money is not equal to withdrawals, disequilibrium will exists. Equilibrium can be regained by change in GDP. Over many years, Keynesian model was used to explain the monetary policy. Keynesian model arguedthat GDP is determined by aggregate demand and governments should manage the level of aggregate demand to avoid recession. (John Solman, p626). However this model will work through influencing expectation (Eggertsson and Woodford ,2003).Expectation played an important role in quantitative easing policy. If people believe that money supply will cure inflation then their will increase investment and if they think otherwise then it will lead to liquidity trap - i.e. injecting money is not equal to withdrawal. (johnSolman, p649)


Economic slowdown has restricted lending and reduced demand and output felled. Main Challenge was to bring aggregate demand and supply to normal. The Bank of England aims to maintain a stable inflation rate of 2%, set by Government. Banks cut the interest rate during slowdown to boost the consumer spending and to reduce the risk of inflation falling beyond the target (bankofEngland.co.uk, 2009). Bank of England has cut the bank rate from start of October 2008 to 0.5% in March 2009. (Michael Joyce et al, 2010). Interest rate of 0.5% is lowest in banks of England's 305 years of history (bbc.com, 2010). But cutting the interest rate didn't ease the credit crunch. To ease the monetary situation further, Bank of England began a programme of asset purchasing known as quantitative easing in March 2009 with the aim of injecting money in to the economy and meeting the inflation target (Michael Joyce et al, 2010). Most of the assets purchased are government bond gilts [2] and other asset purchased was corporate bond. These purchases have expanded the Bank's balance sheet as a proportion of nominal GDP to three times its level before i.e. nearly to 15% GDP.

Bank of England purchased 200,000 million pounds of assets by Feb. 2010. This policy expands the central bank's balance sheet in order to increase the money in the economy (Bernanke and Reinhart, 2004).

With this policy, Bank of England has objectives:

Quantitative easing will reduce the cost of capital on households and businesses

It will improve the capital position of the bank

It will stimulate the growth in money supply to real economy.

The purchase of asset has raised the monetary base but growth in lending activity was slow in 2009 and is improving in 2010 (European economic forecast, 2010). Quantitative Easing came to halt as inflation rate was rising rapidly in 2010 and has overshot the target of bank of England of 2%.


Impact of QE is a humongous two hundred billion pound question. There are various approaches to classify the impact of QE; one way to assess the impact of acquiring assets would be by considering the rise of broad money.(include theory of broad money) A vital reason underlying the asset purchase programme(QE) is a mechanism running from appreciating money balances onto higher asset costs and nominal spending. This mechanism can be simplified using a process of portfolio rebalancing of which the products of different assets adjust for the purpose of willing holding higher level of money balances. The same mechanism if expressed in a monetarist approach, the assets acquired would then work through measures of money disequilibrium which would then increase additional spending. Sometimes these frameworks might be presented as conflicting but essentially they share the same fundamental as why monetary policy at zero bound can spur nominal spending(Spencer dale , 2010)

Banks desire to reduce leverage coupled with the decline in nominal spending means that had monetary injection been absent, broad money would have definitely been much weaker. But this is also indicative of the amount of new debt and equity raised by the UK banks in this period, along with retained profit, totalling over 85 billion pound.

The impact of QE announcements on asset prices over relatively short windows (Bernanke, Reinhart and Sack 2004). Gilt Yields respond to such policies majorly because of two reasons, firstly due to the impact gilt purchases have on yields at which various investors prefer to hold reduced supply of gilts i.e. the portfolio balance effect and secondly due to the impact that the announcement is perceived to contain about the future position of monetary policy i.e. one of the elements of expectation channel. (Spencer dale , 2010)

The variations in the OIS rates post policy announcements are a definite pointer to the extent to which policy announcements impact expectations of future position of monetary policy. OIS rates fell drastically after the initial announcements of QE, predominantly at short horizons, indicating that these announcements were the chief reason for market players to revise downwards the predicted future path of Bank rates.

After implementing QE, equity prices appreciated by over 50%, and corporate bond yields fell over 400 basis points. These variations have been vital for the economy. When asset purchases begun a year before, predictions of such outcomes would have been more than welcomed.

These movements coincided with raking up in global financial markets, which further complicated the task of specifying the UK based effects. However, it is imperative to gauge this global rally with respect to similar policies adopted by the central banks of various important countries - the interest rated were drastically slashed and the balance sheets in many countries was grossly expanded. The fact that UK capital market movement coincided with the global market movement in this period definitely implies that the domestic policy adopted had an impact.

Three major outcomes of QE was through firstly a portfolio rebalancing act because both institutional and retail investors were opting out of gilts into alternative assets, e.g. corporate bonds and equities. Secondly through enhanced market liquidity aided by acquiring more commercial paper and corporate bonds. And thirdly through their impact on expectations as acquiring more assets clearly showed the government's commitment to act which boosted confidence in the economy and reduced the chances of another fall in asset price.

A year back when QE was implemented, its success depended on whether monetary injection and increased asset prices would enhance nominal spending resulting in the 2% inflation target for medium term.


The main reason for failure of quantitative easing is continuation of recession despite of adding money into the system. Though Bank of England has put money into the system, but if doesn't result into the higher spending (Flanders, Stephanie, 2009). If bank is reluctant to lend money and consumers being risk averse in unstable economic condition by not spending money and saving more. As per the theory, MV=PT, rise in money leads to fall in V (circulation), leads to no benefit. This situation could lead to another round of QE i.e. putting more money into the system.

Putting more money could leads to higher inflation. QE is to take company's economy out of deflation spiral; this is done by creating inflation pressure. A small inflation is good but high inflation is disastrous (Andrew Oxlade, 2009). Inflation risk is mitigated if the economy growth outpaces the increase in money supply.

Bank of England will face losses because of success of QE. Low yields of the assets purchased will give losses when the economic activity is resumed. Therefore BOE has to obtain an indemnity from treasury to purchase these assets (gilds, bonds etc) (investmentinsight.com, 2009).

Money supply is not considered good for the currency. When QE plans were rolled out, sterling fell sharply (Dailymarket.com, 2009).As per the theory, if the production increases after the money supply, value of the currency will increase and Bank of England can restore the reserve back by raising the interest rate.

The worst case scenario could be of hyperinflation and a collapse of the British currency / economy along the lines of where Iceland is today which has seen a collapse of some 30% in its annual GDP.(NadeemWalayat, 2009)


It was a year before that MPC had started with large scale asset purchase. The move to quantitative easing evoked mixed reactions, some even predicted it this might result in inflationary tears. Few academics had questioned whether it would have any impact at all or not.

There exists ample economic arguments as to why in the actual world, injecting money into the economy would most likely help achieving that stimulus. Numerous evidences exists, few relatively hard and some rather circumstantial that QE is finally having its desired impact. Asset prices are improving substantially, organisations have achieved record recourses to debt and equity markets leading to greater confidence and fuelling expectations of greater inflation.

Analysis of the financial crisis created many unanswered questions for the theory and implementation of monetary policy. A year after achieving effective lower bound of interest rates and implementing QE, there still remains a lot to be learnt by policy makers and academics. A classics example would be the forced devaluation of currency by China, to gain maximum benefits from the export driven economic policy and a capitalist government which probably leads to destabilising the entire global financial market.

To export a reference to this article please select a referencing stye below:

Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.

Request Removal

If you are the original writer of this essay and no longer wish to have the essay published on the UK Essays website then please click on the link below to request removal:

More from UK Essays

We can help with your essay
Find out more