Quantitative Easing

So the Bank of England has decided to opt for expanding the money supply in an attempt to give the economy the quick-start necessary to prevent a deeper and longer recession. After successful attempts at reflating the economy with interest rate cuts, the previously unthinkable has become not only thinkable but doable. So what exactly is quantitative easing, and will it make any difference?

Before the current recession, the global information economy as we now know it did not quite exist. The previous recession of note was in 1991, when the Internet existed but not within the realm of the general public. One of the consequences of the explosion of global information has been something of a "dumbing down" in the provision of news and other items. This may also be partly an "Americanisation" of news; the CNN factor if you will. Consequently, journalists no longer write articles without concern for headlines, it is the headlines which come first. No phrase can be written without first exploring if there is a "sexier" way of saying it. What is now referred to as quantitative easing has always been referred to in Economics textbooks as expansionary monetary policy: expanding the money supply directly. Most Intermediate Macroeconomics textbooks will examine the impact of such policies using tools such as the IS-LM diagram—first posited in 1937 by the late Nobel Laureate John Hicks—or the Aggregate Demand/Aggregate Supply Model.

Using the IS-LM model, the evidence suggests that in a recession the LM curve is horizontal or near-horizontal. And there is no doubt that we are currently in a recession, which has been both swift and steep. When the LM curve is horizontal monetary policy has no effect whatsoever; it is entirely ineffective. The late John Maynard Keynes likened the use of monetary policy in a recession (or depression) as "pushing on a piece of string"; i.e it would be next to useless. And there have been plenty of occasions when this has been tried in the past and failed.

Given that the policy-makers at the Bank of England are highly intelligent people, with a more profound knowledge of Economic theory and history than myself, one has to question the motive for them engaging in a policy which they know to be ineffective. I can only think of one: they feel the need to be seen to be acting in the face of a recession which does not yet appear to most to be dissipating. However, while I would expect such motivations from elected politicians, I would not have expected the same from appointed technocrats, who must be completely aware of the long-run damage that excessive monetary expansion—excuse me, quantitative easing—can do to inflation rates.

If quantitative easing is not the solution to reducing the impact of a recession, then what is? In a previous posting I argued for expansionary fiscal policy in the form of tax cuts. I still maintain that this would be the best way forward, although this may no longer be an available option given the huge bailouts of so many companies already underway. However, the only true remedy for a recession is to try and turn round public and business confidence, which takes time. With the slight improvement in the weather as winter gives way to spring, we may begin to see the first signs of a change from total pessimism to a more realistic outlook. Barring any additional catastrophes or wars, then I fully expect the recession to begin to end during the late months of Summer 2009. Let's hope that fate does not prove me wrong!