Is Quantitative Easing going to help Britain out the recession?

Essentially quantitative easing is when the central bank of the country creates money out of thin air, so it can be injected into the financial sector. This only occurs when the central bank's base rate approaches zero and is seen as the last weapon in a central bank's arsenal.

Over the past 18 months the Bank of England has made various cuts in the base rate from 5.75% to 0.5% in an attempt to combat falling inflation and to pump liquidity in the market. On the 5th of March the Monetary Policy Committee (MPC) decided to create 75 billion pounds electronically to inject directly into the banking system in an attempt to stimulate the economy out the recession.

A perfect historical example of quantitative easing was demonstrated in Japan. Often referred to as the lost decade (from 1990-2000), Japan had almost no economic growth, deflation and high unemployment. The central bank was forced to lower the base rate to almost zero and faced with no way of creating any more liquidity, the Bank of Japan used quantitative easing to flood the banks with the liquidity. This helped increase commercial and private borrowing which, in turn, increased consumption and brought the economy out of deflation and, ultimately, recession. It would be naive to say that quantitative easing was the main reason that Japan recovered from recession but it certainly contributed.

Fast-forward to the present day and the rest of the world is in quite a similar predicament. The Bank of England is hoping that quantitative easing will be the solution to unclog the current credit markets and allow banks to make credit available to business and individuals. The bank of England also hopes that quantitative easing will help stabilise inflation towards their target of 2%.The Bank Of England desperately wants to prevent inflation turning into deflation as many forecasts predict. Deflation can be extremely destructive - people are reluctant to spend money when they perceive that goods will become cheaper in the future. On the other side of the argument many critics of the Bank of England's policy suggest that it will do nothing to help the recession and instead of helping the economy it will lead to devaluation of the pound as the additional money dilutes the currency value on world markets. Critics also suggest that "quantitative easing" will lead to hyperinflation, since pumping this newly created money into the economy would create upward pressure on prices. It is a quandary and an extremely complex balancing act.

Will quantitative easing help Britain out the recession? Yes, it will help - but quantitative easing is only part of the solution - in our view its main role will serve to help prevent economic conditions deteriorate further.

We take confidence from the speed in which interest rates have been reduced and how quickly the quantitative easing programme has been introduced. It is clear that the Government and Central Bank are prepared to act swiftly to prevent conditions becoming worst.

Only time will tell whether the actions that are being taken will work, but clearly, sitting back and doing nothing is not an option.

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