The Bank of England restarted quantitative easing earlier this month to combat the deterioration of the UK economy. However, past experience shows that this is a blunt instrument for injecting stimulus into the economy.
It’s true that the initial QE injection eased liquidity constraints in the interbank markets and lowered long-term interest rates but the real problem for the UK economy is a lack of aggregate demand both from the UK’s struggling Euro-Zone neighbours and domestically. Handing cash to banks is not the best way to increase demand because it depends on consumers, currently wary of debt, to seek new loans.
Furthermore, the weak economic conditions make it risky for banks to lend to small and medium sized businesses. Therefore, much of the money created by QE finds its way into assets in the financial markets such as government bonds but more importantly commodities. The rise in commodity prices is due more to QE from the US but QE from the Bank of England has ensured that sterling has not appreciated significantly to make up for the rise in prices.
Tuesday’s UK Consumer Price Index hit a 20-year high at 5.2% largely due to the VAT rise earlier in the year and energy prices, driven by the rise in commodity prices. If the FOMC unveils another bout of QE next month, commodity prices are once again likely to maintain upward pressure on inflation.
Instead of QE in both the UK and the US, a combination of credit easing and fiscal stimulus would improve policy targeting without the leakage into commodity prices.