In 2008 the financial crisis affected UK's economy enormously when lack of liquidity "syndrome" in banking and corporate sector was spread from US to the whole world. In new Wall Street Movie, an old American wall street banker Jules Steinhardt described in few words how would world looked after the collapse of the whole banking sector. Without immediate actions from Fed and other central banks the bank sector would not had enough liquidity to perform and operate; and banks without liquidity on their accounts would lead to the illiquidity in corporate sector and also in households. The total "blackout". The most developed economics of the world found themselves at the edge and the federal banks had to spread safe net for the whole world.
The main result of those events was an enormous absence of liquidity, and in very short moment's federal banks decided to release directive instrument, "new tool" of monetary policy "QE" (further just QE). This tool was used by Bank of Japan more then decade ago during the Asian financial crisis. In current crisis UK wasn't an exception and British economy was also struggling as the rest of the world. Since traditional instruments of monetary policy were not effective; especially reduction of bank rate. The Bank of England (further just BoE) had to come up as many other central banks with a huge "QE" package (in UK case) of £200 billion.
Outline the Bank of England's recent policy of quantitative easing?
Recent policy of QE is visually calm and based on the last monetary committee meeting we can conclude that the bank rate would be maintained at 0.5%, asset purchases (QE) maintained at £200 billion. For this preposition voted seven members of committee and two voted against. Mr. Adam Posen preferred to maintain the bank rate at the same level, but he proposed to increase the size of asset purchase programme to £250 billion. Mr. Andrew Sentence preferred to increase bank rate by 25 basis points, but he would keep the size of the asset purchase programme. (Monetary Policy Committee meeting, November 2010).
From first quarter of 2009, BofE started to execute purchases of private sector assets up to 50 billion pounds financed by Treasury bills and the Debt Management Office's cash management operations, and those actions were taken base on the request of the Monetary Policy Committee. The initial fund £50 billion were increase up to £200 billion, which represents 14% of nominal UK GDP. These assets purchases become to be known as "QE".
Currently, we can conclude that 99.93% of assigned funds of £200 billion were allocated to the British economy. The main goal of the BofE in 2008 was to change a fact of lack of liquidity in banking and commercial sector. Even when the whole £200 billion of QE fund are allocated, some banks haven't reconsolidated their balance sheets sufficiently.
The BofE has taken number of actions during the financial crisis and those actions were focused on: enhance liquidity provision (modified discount window, exceptional long-term ops, broadening collateral, expanding counterparties, and foreign exchange swap lines) and assets purchase/funding (government bonds, commercial paper, and other securities).
Perspectives from November 2010 show us that there is a huge possibility of further QE from the BofE. US Fed already released information that would prepare $600 billion package for QE 2, and the Bank of Japan follows this decision in the same way. If the inflation could slightly rise and might be stronger, the BofE would have to continue with further QE. Currently, inflation is over the 3% which is far over the Banks assigned target of 2%. As is quoted in (The Minutes of the Monetary Policy Committee Meeting on 3 and 4 November 2010), "The near-term inflation outlook was more elevated than at the time of the August Inflation Report, reflecting in part recent increases in non-energy commodity prices and news about utility prices. On the upside, there was a risk that a prolonged period of above-target inflation would cause inflation expectations to drift up, making it more costly to bring inflation back to the target in the medium term."
Also there is a risk that demand of private sector will struggled and this might affect employment rate growth and this might result of undervaluation of labour as source and this might affect inflation by pushing it down under 2% level in mid-term horizon. On the other side, if inflation will rise, it would be dangerous for the BofE to release second QE package.
How successful was the policy?
Monetary policy which has been applied into the British economy had to deal with economic recession. It is evident that QE helped to boost financial markets and stock prices, which might create suspicion about future prices bubble. There are many positives from QE and negatives not much known yet, but as Stephanie Flanders quotes: "QE may well have saved the economy from a credit-led depression. We will never know."
The best way how to describe effectiveness and success of already mentioned policy is to compared on the time scale. I have compared two inflation indicators CPI and RPI, macroeconomical indicator GDP and announcement dates of QE decisions.
As we can see on the graph the UK economy felt into recession in May 2008 and lowering the bank rate helped to boost GDP. One of the first actions of monetary committee was taken in February 2009; when BoE mentioned that there is high probably of using the QE tool. After that in March 2009 the BofE released £75 billion for asset purchases and lowered bank rate from 1.0% to 0.5%. In May 2009 the bank increase plan up to £125 billion. After this action the trend change CPI started to rose and also RPI (which represents real prices inflation) had been rising and in Aug 2009 it rose over the zero bound. Later actions just increased the QE amount to £200 billion, but the bank rate stayed still. As we can see at the edge of 3rd and 4th quarter of 2010 the development is "asking" for further stimulus to keep the rising direction. The UK economy due to the central bank stimulus firstly during the recession growth in 3rd quarter of 2009, which was a signal of getting out of the recession for British economy.
As I mentioned previously, experience from Japanese example warn BofE that QE may come with deflation effects, and the BofE has used two instruments for achieving avoiding also potential treats of deflation by lowering bank rate and by QE. The executive body of The BofE the Monetary Policy Committee decided to cut bank rates in UK from October 2008 from 5% to 0.5% in March 2009. This action allowed banks to borrow cheap money, but most of the banks kept that money on their accounts which was a signal that banks want to increase liquidity. Lowering the bank rate solved primary problem with bank's liquidity, but it didn't help to boost economy performance and actually to help moving out of the recession.
When interest rates rise above the zero bound, does quantitative easing imply that the Bank of England now has two policy instruments?
As far as I have correct information, the BofE hasn't lowered bank interest rates below zero bound, yet; the minimum level of bank rates has never been lower than 0.5%. If we just assume that bank rates are over zero bound, it will mean that the BofE is using indirect instrument of monetary policy to influence amount and value of the money in the economy. On the other hand, if we assume that together with the bank rate regulation the BofE is also using QE tool, it would seems to be true that the BofE has two policy instruments.
I would agree with the idea, that using bank rate and QE tool means that the bank has two policy instruments. The bank rate is very commonly used monetary policy instrument in develop economies. The theory says that more direct instruments are used in emerging and less develop economies and more indirect in develop economies. I would agree also with that, but our world of central banks, interconnected macroeconomics and globalized companies is still in development. Currently, every major central bank is using QE and since this tool is directive instrument it can be suggested based on the monetary theory that countries are not as develop as they're trying to look.
The QE is itself solely directive instrument and helps banks very quickly and relatively effectively stimulates economies. Based on my studies and current bank world situation I would say that following 40 years will be very turbulent in financial sector. From 1900 to 2000 our world went through industrial development and from 2000 to (at least) 2050 our world will go through macro financial development. The one third of world population is located in China and India, and development of those countries will affect world enormously.
Based on those changes, also monetary policy and policies of central banks will keep changing. Currently, the whole world has faced financial crisis and development of QE as directive instrument hereby with indirect instrument - the bank rate. It may sounds idiotically, that direct and indirect monetary tools are helping economies to get out from recessions. I believe that the BofE (and other central banks) has two policy instruments which might help economy to boost and prosper, but macroeconomical studies have to examine those tools along with others to design the most effective tools combination for dealing with economical downturns.
Conclusion
The BofE reaction to the banking crisis was recalled due to the global downturn which affects rapidly the biggest world economies. The bank began a program of QE in year 2009 in its first quarter and the fund had gradually arisen to £200 billion.
Markets reactions on this directive monetary tool were that gilt yields drop down by 100 basis points, which was the lower level than during normal times. All analyses haven't measured all effects of QE and not all the affected indicators of economies were pronounced as successful results. For many affected indicators as demand, bond prices and the others the future will show how efficient was monetary policy committee during the current financial crisis.
As I mentioned previously, currently, we can conclude that those actions which were taken have boosted some parts of market, e.g. asset prices. A quite large scale of uncertainty is linked to the effects of current monetary policy on agency debt and agency mortgage-backed securities which are still in the portfolios of the Bank's in the United Kingdom. The effectiveness of QE asset purchases itself will be judged by their impact on the state macroeconomy and global economies, too.
