Quantitative Easing Explained

Published / Last Updated on 27/01/2015

Video explores government borrowing and sovereign debt and buying back debt using QE quantitative easing.

Transcript:

“Hello again and thank you for joining me. I get asked quite a lot: “what is quantitative easing?”

We see the term a lot: America's QE programme, Britain's quantitative easing has been frozen as part of the Bank of England monetary policy committee and even recently, I'm shooting this video in January 2015, and the European Central Bank have confirmed that they are making the unprecedented move to quantitative ease at €60 billion per month because they're worried about inflation or should I say negative inflation i.e. deflation and the whole of Europe running into basically reverse.

So what I thought I would do is explain the quantitative easing is, bearing in mind the United States has employed this, the United Kingdom, with £375 billion of quantitative easing, Japan with very similar numbers, quantitative easing to stimulate their economy and now Europe with €60 billion per month which potentially by the time it's finished could be up to €1.1 trillion injected into the European economy.

So first things first what's it all about? In simple terms, it's fears of government of negative inflation i.e. deflation. Trying to stimulate the economy because the problem with deflation is if your loaf of bread costs a pound today but because prices are going down it'll cost you 90p next month, you’re going to put off spending your money and that's the same, from a deflationary perspective, whether it's buying cars, televisions food items, goods, services et cetera and fundamentally that ‘kills’ the economy. So all governments and central banks are fearful of negative inflation i.e. prices going down because if you can buy it cheaper next week why would you buy this week?

Now what happened going back with the credit crunch crisis and particularly the United Kingdom and United States, we embarked on a quantitative easing programme. Now you've probably heard the term “national debt” and “the public sector borrowing requirement” and what that basically is, is for our government to build hospitals or schools or infrastructure or roads or to pay for benefits or whatever it might be, not all of it is covered by revenue from taxation and potentially the government needs to borrow money.

The United States government is massively in debt, the United Kingdom is massively in debt and I don't even need to talk about Greece and things like that in terms of Greece, Spain, Italy etc. and Ireland, in terms of their borrowing. Although Ireland have done some good things now. But fundamentally, governments borrow money. They borrow money and they issue loan stock. Think of it like you are lending your money to the British government that's a loan or what we call it in the United Kingdom is ‘Gilts’. A gilt edged security because it's gilt-edged because it's backed by the government.

So you lend or investment companies or your pension company, they lend the British government money, they are issued with a gilt stock or if you’ve played Monopoly you probably seen: “Your Treasury Stock Matures”. So Treasury stocks are issued , the government’s borrowing money, the government then agreed to either pay you a fixed rate of interest for a fixed period or alternatively they will inflation proof it with index linked loans or index-linked gilts. So that's what gilt is and in the case of America or Europe just think of it like sovereign bonds. They call them bonds, government bonds. So government bonds for the rest of the world, for the UK we tend to call them gilts.

[So] lending money to government, government can then build on motorways and things like that and you receive a fixed rate of interest and then at maturity your loan is repaid “the Treasury stock mature’s”. So you have an investment that is backed by a government.

Now Europe, Britain, America, the problem with the credit crunch crisis and more recently with Europe where it is slowing down, the economy slowing down, they’re fearful of inflation, is they need to stimulate the economy. They need more money in supply, more money out in the economy means potentially more stimulus so what they are doing is:

I’ll give you the example and make it up. Let's say the British government borrowed some money 10 years ago and issued a gilt stock, a bond stock, paying 5% per annum. Interest rates dramatically lower today, so they can borrow money more cheaply because people believe that the British government is stable.

So what they do: Quantitative easing is printing money, so they’re printing money, the Bank of England is. It then buys back government stock, government debt, so it effectively paying off government debt early but not by the fact that we’re a fantastically recovered economy, they’ve been printing money but they buy back the government debt so they pay their debts off and as a result: things like banks who lent the money, things like insurance companies, pension funds, professional investors: they now have cash pound notes sat in their bank accounts because they've had their debt repaid early and that pushes more money into the economy, hopefully stimulating the economy.

[And] via a backdoor what does the British government do then? Next week it goes and borrows again, it has another bond auction, another gilt auction and borrows some money. So printing money in the middle, paying off debt over here, paying the old debt off, quantitative easing, we are easing the cash flow of the economy but then via the back door, still borrowing it again but at cheaper rates and that's what happening in Europe as well.

Now like I say with Europe, an unprecedented move because they weren't supposed to look at any form of quantitative easing or stimulating the economy that way. Well, they’ve made the announcements: €60 billion a month and what they will be doing is buying back European Central bank debt and releasing more euros into the economy with a view to stimulating the economy. It's the old thing of, it’s like any of us, if you get a bonus, if you’ve got more cash in the bank, more cash flow, you spend more.

So that’s the theory of quantitative easing. In simplistic terms, quantitative easing is buying back central bank debt whether it's the Federal Reserve, whether it's the Bank of England, Bank of Japan or more recently the European Central Bank. So buying back the debt, paying it off technically early to release more money, more cash flow into the economy and as you know it's supply and demand economics the greater the supply then people start spending money et cetera. So hopefully that gives you a nice insight into what quantitative easing is or QE for short. Thanks very much for watching.”



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