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Why hasn’t quantitative easing worked for the UK economy?

Kathleen Brooks

Ministers have waxed lyrical about how the UK economy would avoid another recession and start to grow this year, or at least stagnate. But according to the Organisation for Economic Cooperation and Development (OECD) we are going to enter another recession on April’s Fool Day.

It predicts that the UK’s economy will have contracted by -0.3% in the first three months of the year, coming after a 0.3% dip in growth in the last quarter of 2011.

Two consecutive quarters of negative growth is the technical definition of a recession, so it’s back to the doldrums for the UK economy.

[Related Article: Britain back in recession, OECD says]

But how can this be? Hasn’t the Bank of England’s (BOE) second round of quantitative easing (QE) helped us all?

Well, yes and no. It depends on what the Bank wants to achieve with its asset purchases. The second round of QE that started in September of last year was a pre-emptive move in case the Eurozone debt crisis exploded leading to a Lehman-like economic crisis. The UK is very exposed to Europe’s economy and rather than promote growth QE was used as a monetary buffer to ensure that in the event of a major problem over the water the banking system had enough money to survive.

This was followed in February with another £50 billion of funds from the BOE. The reason for this move is slightly less clear. The economy had shown signs of picking up (it has since deteriorated) and the Eurozone crisis had stabilised somewhat. However, the market expected QE so the Bank had to give it what it wants.

So what are the benefits? Primarily QE is designed to pass money to the banks through the funds they receive from selling their UK government debt back to the Bank of England, which is then lent out to the wider economy. That is the traditional view, but it has some other effects too. If there is a buyer of Gilts with a voracious appetite (like the BOE) then it reduces borrowing costs for the government – as bond prices rise, yields fall. This is fantastic news for a country that needs to borrow GBP 126 billion this year to finance its budget deficit.

Another benefit is that QE can help boost confidence in the economy and cause asset prices like stocks to rise. So QE is great news if you are the government or someone with a large stock portfolio, but QE doesn’t help the local economy in the same way as it does financial markets.

For example, one of the biggest problems in the UK at the moment is rising unemployment and youth unemployment in particular. But just because QE has re-started doesn’t mean that more jobs are going to be created. Banks may not lend out money because they need to hold larger capital buffers due to new regulations. Also, they may be under financial pressure and are worried they may not be able to finance themselves in the wholesale funding markets going forward. Hence they squirrel the money away and the small business owner doesn’t see a penny of it.

[Related Article: Dip in UK consumer morale dents recovery hopes]

Likewise, most small and medium-sized businesses in the UK rely on banks to fund themselves, not the capital or bond markets. If they used bond markets then they would find access to funds much easier.

Interest rates, even for low investment grade companies, have been falling and corporate bond issuance in the US, where companies are active in the bond markets, has topped $1 trillion in the first three months of the year. Thus, to really benefit from the effects of QE you need to be active in financial markets.

As expectations grow of more QE in May if the UK falls back into recession, the public needs to remember that QE only effects the upper echelons of the economy, and just because the BOE prints more cash doesn’t mean that the unemployment rate will come down anytime soon.