The standard monetary policy is to manipulate the money supply in order to increase or decrease the market interets rate. During the downturn of the business, the central banks will impose a expansionary monetary policy to lower the interests rate by increasing the money supply, the investment will therefore increase since the cost of borrowing money has declined in order to boom the whole economy and the aggregate demand.
However, since the Bank rate was already been reduced to 0.5% by early March 2009 in the UK, It is difficult to boost the economy as a whole without any further monetary policies. The inflation rate, annual change in the CPI, will fall below the government’s target 2%, therefore, the Monetary Policy Committee decided to purchased total £375 billion assets (gilts) in three phases to prevent from a lower employment rate and a sharp construction in the productivity.
“Purchases of financial assets – which in the United Kingdom have mostly been UK government bonds (gilts)– from the private institutions financed by the issuance of central bank money increased private sector broad money holdings”. When the central bank purchased the gilts, the banks or investors will hold more money and less assets, they will choose to rebalance their portfolios by investing in other assets such as shares or corporate bonds. Besides, under the QE1 in the UK, the demand for gilts rose as well as its price for approximately 50%, the yields was reduced to around one percent, which mean the rate of return of purchasing gilts has become lower, thus, people also will buy other assets and push up the prices of those assets, the yields of assets in the economy as a whole are declined, that is the cost of borrowing for the household and the investors become lower, since the investment acts as a injection in the economy, the national income will be increased as well as the aggregate demand, the consumption and the wealth of the assets holders will raise, the inflation rate to meet the government’s target eventually.
Since the central bank bought assets directly or indirectly, the market functioning will be improved and the economy will be stimulated by increasing the liquidity of the market and encouraging the trading in the financial market while the financial market became dysfunctional in the crisis. Furthermore, the consumers’ expectation will be improved because without operating the quantitive easing, many people would been lose their jobs due to the bankruptcy of many companies such as the Lehman Brothers and been worse off and the recession will be more severe. Consumers will be more confident while the unemployment rate being reduced, they will spend more money on goods and services, the aggregate demand will be expanded, between March 2009 and January 2010, the level of real GDP have raised by 1½ to 2%.
Quantitive easing also consider as printing money, the central bank directly inject the newly minted money into the market, the money supply will increase which will depreciate the currency, since the sterling, for example, becoming cheaper compared to the other currencies, the export’s price will be relatively lower and the quantity of exports will raise, likewise, countries will import less products with higher prices, and might be beneficial to the balance of payment to some extent.
On the other hand, It is noted that the money supply might not be expanded while banks hold the money as a liquidity reserves, therefore, if the banks do not lend out the money, this policy will be ineffective since both funding and market liquidity declined. Not