Do we need more government help?
Fans of quantitative easing would argue that it helped the UK exit the recent recession but critics describe its impact as limited at best.
With a fresh round of spending cuts in the offing, Stuart Thomson from Ignis Asset Management believes another dose of quantitative easing is needed, while Dr Stephen Barber from Selftrade argues that the new spending cuts won't have as big an effect as perceived, rendering further easing unnecessary.
YES: says Stuart Thomson, chief economist at Ignis Asset Management
Economics is simple: if you throw enough money at an economy, it will grow, but if you withdraw this stimulus while the financial sector is still de-leveraging, then it will slow. The preliminary second quarter GDP data provides a perfect example of this process.
The economy grew by 1.1% in real terms. Unfortunately, this is as good as it gets for the fledgling recovery. This performance was driven by extraordinarily loose monetary and fiscal policy.
Fiscal expenditure will move from feast to famine in the second half of the year, with the new coalition government accelerating spending cuts and tax hikes, adding a cumulative £40 billion of tightening over the next four years to the £73 billion authorised by the previous Labour government.
The experience of economies recovering from deep financial sector-led recessions is well documented and suggests that economic activity remains subdued and vulnerable for up to five years after the recession ends, while inflation continues to slow for three years. The case for more quantitative easing rests with the national balance sheet.
Fiscal austerity represents increased government savings, which over time should be balanced by increased spending by consumers and companies that have built up savings during the recession.
However, timing mismatches driven by companies' efforts to pay off debt, can lead to planned savings exceeding planned investment, resulting in insufficient overall demand and ultimately recession.
In this environment, the monetary transmission mechanism is impaired, and near-zero base rates are unable to stimulate a self-sustaining recovery.
The solution is for the central bank to purchase government bonds to lower the term structure of interest rates and encourage consumers' and corporates' animal spirits.
NO: says Dr Stephen Barber, an academic adviser on economics and markets for Selftrade
Although quantitative easing was useful when employed in the aftermath of the credit crunch, the current public spending cuts are unlikely to affect overall demand in the economy quite as much as is popularly suggested.
While important for a time, over the cycle, loosened monetary policy and its corresponding devaluation of sterling have been far more important than stimulus-spending in sustaining recovery.
At its July meeting, the Bank's Monetary Policy Committee voted to continue with quantitative easing asset purchases to the tune of £200 billion.
My judgment is that should more quantitative easing be required in the immediate future, it will be aimed at out of target prices rather than as a substitute growth stimulus.
The chancellor's plan to balance the budget over the course of five years is both ambitious and fraught with risks – both to his own reputation and to the health of our economy. Spending cuts are going to be painful and will have a detrimental effect on consumer confidence.
Nevertheless, we seem to have developed a flawed mentality that considers 'public spending' and 'fiscal stimulus' to be interchangeable terms. But not all spending is stimulus, and while all will have some beneficial effect on domestic demand, a lot of it is inefficiently targeted.
Meanwhile, June's Emergency Budget maintained important capital spending, which is likely to be a significant contributor to economic growth in the coming years.
Given the eurozone woes, the alternative scenario of not tackling the structural deficit has implications for the ability of policymakers to manage monetary conditions.
Furthermore, as US Federal Reserve chairman Ben Bernanke's recent comments attest, quantitative easing could be employed were deflationary pressures to re-emerge.
At the moment, such pressures seem evenly balanced, so quantitative easing is not necessary.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The total money value of all the finished goods and services produced in an economy in one year. It includes all consumer and government consumption, government spending and borrowing, investments and exports (minus imports) and is taken as a guide to a nation’s economic health and financial well being. However, some economists feel GDP is inaccurate because it fails to measure the changes in a nation's standard of living, unpaid labour, savings and inflationary price changes (such as housing booms and stockmarket increases).