Best Way To Simulate Economy

Readers Question: I am wondering why the 75 billion of quantitative easing that the Bank of England announced today to be “injected into the economy” isn’t spent on infrastructural projects? Why spend those funds on government bonds? This doesn’t seem to be the best way of using these funds. Many thanks.

It’s a good question. I wrote on the latest round of quantitative easing here: Keep Calm and Print Money

I think the Bank of England would respond by saying it is out of their remit to start deciding which infrastructure projects to start giving money to. Their constitution probably doesn’t allow giving money directly to firms who promise to invest. It would make the Bank of England more political. Their remit is just monetary policy not fiscal policy as well.

By buying government bonds (they could also buy corporate and mortgage bonds) the Bank of England takes a more neutral approach. They say it is their job to:

  • Reduce interest rates on bonds
  • Increase money supply

They hope this will prevent double dip and prevent inflation falling below target in medium term.

But, then it is  up to free market to respond and decide how to use extra money.

The problem is that banks are largely sitting on this created money, therefore some doubt how effective quantitative easing actually is. Though there are also signs that quantitative easing has led to some monetary stimulus – sufficient to create a slightly higher growth rate. In this case, quantitative easing (though imperfect) is better than doing nothing. Another round of QE is important for to avoid a slide into a second recession.

See: Keep Calm and Print Money

Government Investment

Some economists would argue that in a liquidity trap and recession, it is up to the government to increase spending on infrastructure. The government could take advantage of very low bond yields to increase government borrowing and finance expansionary fiscal policy.

If the government invested in public infrastructure schemes, there would be a more direct economic stimulus and the quantitative easing would have more benefit.

The present government won’t do this because they are committed to reducing government spending. They argue reducing government borrowing is essential given scale of UK debt and concerns over Eurozone debt.

However, this fiscal austerity is one of main reasons why the Bank of England has had to step in to create money. Arguably, the very low rate of interest on government bonds is a sign the government should finance fiscal expansion, at least in short term.

I advocate this fiscal expansion in – policies to avoid a recession

Note: Some members of Bank of England (Adam Posen) have suggested government set up a national bank to lend directly to small firms, bypassing commercial banks who are sitting on their cash reserves. This would also make better use of created money.

Who Benefits from Quantitative Easing

Here I looked at who benefits from quantitative easing. It’s mainly banks who benefit from selling bonds to the Bank of England. Also, because of the economic downturn, only a small % of this ‘new money’ was actually lent out to firms willing to invest in infrastructure.

Have Your Say – Should the Government spend money on Investment and delay the spending cuts?

– leave comment below for how you think we should be stimulating the economy.( if at all)

Other policies to stimulate economy

4 thoughts on “Best Way To Simulate Economy

  1. Every time there is a recession, infrastructure projects get trotted out, sure as night follows day. There is actually no reason whatever to spend on infrastructure rather than a broad range of public and private sector goods and services.

    Second, it takes time to get infrastructure projects going, by which time the recession might be over.

  2. “The problem is that banks are largely sitting on this created money”

    Help me out here please – why should negative interest rates not be introduced on funds deposited with the BoE ? (which is what I assume the above means?)
    Make the banks support business!

  3. Banks will not lend while they still have un-declared losses to cover up.

    1st. Do you believe the Earth has unlimited resources?

    If so carry on, but if you find that this is not true then maybe we need to consider how our children and grand-children will manage?

    Growth consumes resources and I believe we need to find a more equitable way forward.

    Borrowing and spending in my books have to stop, as do the gold plated pensions dished out by government.

  4. Perhaps we should be aiming for 0 growth, a far greater redribution of wealth, improved publc services, severe ecological planning, massive supply side investment on projects which add social, scientific knowhow and a cultural revolution that makes taxation the main tool of expansionary and deflationary policy in a last-ditch attempt at bringing some sense of proportion and perspective into a world which since 1971 and the convertibility of US debt from gold to dollars (leading to massive currency speculation) thus paving the way for monetarist ultraliberalism which has created more ecolgical devastation, (probably irreversible) economic destructuring (through deregulation) and brainwashing (ultra consumerism and the celebrity culture). “We have a real principle of uncertainty problem here”. So much dumbing down may have seriously damaged our health. I find even refering to our children’s future in any terms other than appalling verging on the dishonest, at least for those of us old enough to know better.

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