Quantitative easing: The £100 billion gamble

A report from Reuters in late April made the cost of the quantitative easing (QE) programme, in play since 2009, frighteningly clear, saying it “would rack up a total financial loss of around 100 billion pounds ($125 billion) by 2033, which will need to be funded by the government”.

The annual cost for the government, the report said, would be £30 billion this year, and the same next year and in 2025.

QE was intended to encourage lending and spending, to stimulate the depressed economy. Unlike other economic tools, such as the central bank increasing cash rates to stifle spending and rein in inflation – as we’re seeing around the globe right now – quantitative easing had a very different goal in mind.

Whilst keeping a close eye on inflation, its purpose was to create an environment in which people and businesses were comfortable to spend and invest more than they previously were. For the most part, it worked.

QE operates by the central bank injecting money into the economy, typically through the purchase of government bonds. This is intended to boost lending by commercial banks to individuals and businesses, to lower interest rates as the prices of government bonds rise and their yields fall, and to stimulate spending and investment in an environment of lower interest rates.

Is there any risk?

If that all sounds too simple, that’s because it is.

The biggest risk in the process is inflation. There’s a very good reason that central banks sometimes act to quash spending. When spending is high, and particularly in an environment of supply chain challenges and shortages of goods and services, inflation can very quickly rise.For this reason, the Bank of England had to monitor inflation levels during the QE programme to ensure they remained within a specific range, ultimately targeting two per cent. But inflation has now leapt, higher than 10 per cent.

When the Bank of England first used QE in March 2009, during the global financial crisis, the economic environment was very different. The Bank of England pointed to the very low Bank Rate at that time as necessitating new solutions.

“In fact, [the Bank Rate] couldn’t be lowered any further at that point. So we needed another way to lower interest rates, encourage spending in the economy, and meet our inflation target,” a report by the Bank of England says.

“In total, we bought £895 billion worth of bonds. Most of those (£875 billion) were UK government bonds. The remaining £20 billion were UK corporate bonds. The last time we announced an increase in the amount of QE was in November 2020. At the moment, inflation is above the 2% target, so we have raised interest rates to bring it back down again.”

Why inject money into the system to increase spending if you’re just going to raise interest rates to suppress that spending? Because when interest rates are already low, there are few other options. A car needs an accelerator and a brake, and the Bank of England is trying to use both.

QE causing an ‘everything bubble’

Alexander Tziamalis, a senior lecturer in Economics at Sheffield Hallam University, wrote in April 2023 that the current four-decade-high levels of inflation are not transient. It will be a long time before inflation drops from double digits to two per cent, he believes.

“The truth is that the global economy is now entering a period of permanently higher inflation fuelled by four deeper forces,” Tziamalis says.

Those forces are de-globalisation, the effects of climate change on food supplies, a wage-price spiral that has already been allowed to run its course, further lifting inflation, and the high levels of liquidity in global markets caused, in large part, by quantitative easing.

“What started as a reasonable measure to shore up the banking sector and help households and businesses via low interest rates became an addictive habit in the 2010s. QE liquidity is now equal to 40% of GDP in the US and UK,” Tziamalis says.

The value of assets has been boosted by quantitative easing, he reports, causing what he refers to as an “everything bubble”.

This could bankrupt households and businesses, and it is already leading to the collapse of banks, he says.

In a less prolonged economic crisis, such as the events of 2008/9, quantitative easing has been proven effective. In 2009, Professor Ian Tonks from the University of Bath worked with the Bank of England to research investment behaviour. The analysis revealed that spending was broadly in line with what the Bank of England was hoping to encourage.

However, that particular episode of quantitative easing was small fry compared to the one it has grown into, today.

In 2009, bonds purchased by the Bank of England roughly added up to £200 billion. In 2012, in response to the Eurozone debt crisis, that total rose to £375 billion. In 2016, after the Brexit referendum result, it leapt again to £445 billion. And in 2020, thanks to the pandemic, it reached £895 billion.

Of course, some of that debt is now being gradually sold off and, as mentioned, the loss is expected to add up to around £100 billion.

The impact of the QE sell off

For businesses and individuals, selling off the debt means there will now be less money in the economy.

Fortunately, the sell-off is happening very slowly. In a recent letter to Andrew Bailey, the Governor of the Bank of England, Chancellor of the Exchequer Jeremy Hunt gave the go-ahead for the sale of just £30 billion of assets.

“This will be reviewed and confirmed between us again in October 2023,” the Chancellor wrote.

An end to quantitative easing may also make predicted tax cuts more difficult to implement, with a large debt now to be paid from the public coffers.

Of course, spending will fall, and so should inflation. In the meantime, small businesses can likely expect to be trading in a tighter and more price-sensitive market.

Other macro and micro risks will reveal themselves along the way – after all, the Bank of England has never before unwound a quantitative easing programme. It’s all the more reason for proceeding slowly and cautiously, to gradually discover what the future holds.