Economy could be boosted with more cash
The head of the Bank of England wanted to inject a further £75 billion into the British economy in August, but was outvoted by other members of the Monetary Policy Committee (MPC), it has been revealed.
Earlier this month, the MPC decided to hold the base rate at 0.5% and increase its quantitiative easing scheme (the creation of more money) by £50 billion to £175 billion. However, the minutes of its meeting now show that Mervyn King, governor of the Bank of England, proposed increasing this amount further to £200 billion.
Although fellow MPC members Tim Beasley and David Miles agreed with King's proposal, the other six members voted against him. This is the third time King has been outvoted by the MPC since joining in July 2003.
The news that the MPC was split over the decision to extend quantitative easing is not surprise; however, economists were predicting that any dissenters would have voted for a lower increase in the expansion of the programme. The Treasury originally set a £150 billion ceiling on the amount of money that could be created through quantitative easing, and King was forced to seek permission to extend this to £175 billion.
The three members in favour of even move money being pumped into the scheme argued that any negative consequences of such a move would be "less severe" than the potential costs of acting too "cautiously”. They warned that insufficient extra funds into the scheme would cause inflation to remain below its 2% target for a sustained period of time and might also knock public confidence in economic recovery - thus causing said recovery to falter.
However, the majority of the MPC disagreed. They argued that many of the risks facing the economy had receded and that substantial injections of money into the economy might result in inflation rising rapidly.
All members of the MPC agreed to hold the base rate at 0.5% for a further month.
Analysts now believe that yet more cash could be pumped into the scheme to get the economy back on its feet.
Vicky Redwood, UK economist at Capital Economics, says: “Since the meeting we’ve had some unexpectedly strong inflation figures [inflation is falling at a slower rate than originally expected]. But if, as we expect, that turns out to have been a blip and the economic recovery is weaker than the MPC expects, there is a good chance that the MPC will extend the quantitative easing programme again in November.”
Ian Kernohan, an economist at Royal London Asset Management, adds: “It's clear that the bias on the MPC is to err on the side of risking higher inflation, an outcome they feel they can deal with, in order to avoid the deflation trap, which they would find much harder to tackle. Expect more excitement next year, when they attempt a smooth exit from all this monetary largesse.”
If inflation is to rise substantially, then the MPC might decide to increase the base rate sooner than originally expected.
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.
This is the opposite of inflation and refers to a decrease in the price of goods, services and raw materials. Economically, deflation is bad news: the only major period of deflation happened in the 1920s and 1930s in the Great Depression. Not to be confused with disinflation, which is a slowing down in the rate of price increases. When governments raise interest rates to reduce inflation this is often (wrongly) described as deflationary but is really an attempt to introduce an element of disinflation.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
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).