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Why pensioners shouldn't fear quantitative easing

Saving | Savings Accounts

By Justin Modray, published 05 July 2012.
Helpful? 57

The Bank of England has announced it will pump a further £50 billion into the ailing UK economy, pushing its total stimulus package to £375 billion. Is this a good or bad thing and will pensioners suffer?

Will this extra £50 billion succeed in igniting the economy?

I doubt it - the £325 billion the Bank has thrown at the problem so far appears to have failed, although we might arguably be in an even worse position had there been no 'quantitative easing' (jargon for throwing money at the problem) at all.

How is quantitative easing supposed to work?

The idea behind quantitative easing is that the Bank of England creates new money then uses it to buy financial assets such as gilts and corporate bonds from banks. It hopes banks will then lend this money to individuals and businesses who will subsequently spend it, creating more economic activity and pulling our economy out of the doldrums.

Why does it seem to be failing?

Banks still appear reluctant to lend to businesses and individuals are generally reluctant to borrow money then spend it. So while some of the cash does ultimately find its way into the wider economy, the majority is probably being retained by the banks to boost their reserves - or being gambled by investment banks to try and make yet more money (which can lead to rising share prices in the short term as more money heads into stock markets).

Does quantitative easing impact elsewhere?

There's an argument that it pushes up gilt prices, which reduces yields. This is bad news if you're buying an annuity (e.g. about to retire) as it's likely to push down rates due to annuities being backed by gilts.

This might be the case, but hard to know for sure as gilt prices have also generally risen in recent times due to demand from nervous investors fleeing riskier investments for safety.

The other main argument is that quantitative easing leads to rising inflation. I've already had a few emails today from various pundits proclaiming quantitative easing will 'crucify' pensioners because of higher inflation (which would erode their savings etc). In my view this is unlikely to be the case and such comments are naive and misguided.

Why shouldn't pensioners fear quantitative easing?

For one very simple reason - in the current climate quantitative easing doesn't seem to be encouraging higher spending. We have seen high inflation in recent years, but that's been due to higher energy and food prices - not higher business and consumer spending. And energy/food price movements are more a result of global demand and supply than changing UK demand.

Strip out the impact of energy, food and excise duty increases on tobacco/alcohol and inflation really shouldn't be a concern.

I would be worried if bank cash stockpiles lead to a glut of cheap lending in future (as that probably would lead to more spending and higher inflation), but I don't think it's a realistic prospect as things stand.

Does the Bank of England have any alternative?

While I'm far from convinced quantitative easing will work, I don't blame the Bank of England for trying - it's really the only tool left in its box. Cutting interest rates would be the other option, but with rates already rooted at 0.5% there's little scope to do so.

However, a better route might be for the Bank of England to lend directly to companies, as this will ensure the cash reaches the coalface rather than remaining in bank pockets. This could be achieved by either buying corporate bonds directly or offering loan facilities. Both raise a big issue - how would the Bank of England decide who to lend to? but it surely stands a better chance of working than the current setup.

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