Inflation has been one of the most used words in the last couple of years and has been the bane of households, firms, and governments. Given the unprecedented scale of the pandemic, central banks were forced to inject money into economies, with demand falling at an alarming rate, wiping out years of economic growth. Despite inflationary risks, central banks decided that the present was more important, with rising unemployment and falling investment posing huge threats. Unfortunately, the gamble of central banks came to bite, with Russia’s invasion of Ukraine worsening an already fragile situation. Britain’s precarious situation made it one of the worst hit by inflation, as inflation rose from 0.2% in August 2020 to 11.10% by October 2022 (Y charts, 2024).
What is Quantitative Easing and why did the banks do it?
One of the key drivers of the current inflation surge was a significant increase in demand, and it is assumed that the Quantitative Easing (QE) program introduced by the Bank of England (BoE) had a role to play.
QE is a form of monetary policy that refers to the large-scale buying of bonds and securities, by central banks, to increase cash flow during periods of reduced economic activity. This injection stimulates consumption and investment, increasing demand, especially when interest rates cannot be lowered.
The main way in which central banks inject money into the economy during a downturn is through lower interest rates, as it disincentivises saving, incentivises spending and decreases borrowing costs, stimulating investment. However, despite interest rates at an all-time low of 0.1%, in March 2020, the economy was struggling. The QE process began that month, with the BoE launching a QE program and by the end of it, BoE held £895 billion of bonds (Milliken, 2022). This helped the government send financial aid to households, with the gilt purchases acting as IOUs.
As lockdown started, the UK and foreign markets also witnessed a ‘dash-for-cash’. Despite government bonds being one of the safest and most stable assets, investors were offloading them. Therefore, to prevent massive deterioration in the gilt market and reduce ‘tightening’ financial conditions, the BoE “very quickly” outlined the QE program. They succeeded, with medium and long-term gilt yields falling approximately 40 basis points (Fillipo, et al., 2022).
Issues and repercussions of the Quantitative Easing Programme
The manner in which the BoE carried out QE gave the appearance of fiscal dominance, undermining its ability to remit inflation. Although the QE resulted in the purchasing of both corporate bonds and gilts, the majority of money spent was on gilts, thereby directly facilitating excessive government schemes. BoE asset purchasing nearly perfectly matched the government’s borrowing needs (Stubbington & Giles, 2021), undermining its ability to remit inflation, independent of government demands.
Furthermore, the QE program exacerbated an already growing savings ratio. Over lockdown, the UK saw a rise in household savings, as consumption decreased heavily, and precautionary savings rose. It is estimated that net consumption between Jan-Mar 2020 and Apr-Jun 2020 decreased by £80.5 billion (ONS, 2020). This was largely driven by the fall in eating out, travel, and non-essential retail, with restaurant and hotel spending decreasing by 88.4% and recreation spending decreasing by 17.7% (ONS, 2021).
Majority of households were still on either payroll or being helped by government grants (furloughed employees received 80% of their wages). The furlough scheme itself cost £70 billion, supporting 11.9 million jobs (Clark, 2021). Unprecedently high excess household savings coupled with increased wealth due to rising house prices, facilitated a steep increase in consumption exiting the lockdown, leading to demand-side inflation.
Evaluation of the Quantitative Easing Programme
Exiting lockdown, there was a huge increase in demand, with GDP rising month-on-month. The UK saw a huge surge in demand for restaurants, flights, and non-essentials; inflation saw a gradual rise from 0.4% in Feb 2021, to 5.4% by Dec 2021 (Y charts, 2024).
One could argue that BoE was lenient throughout the QE program. Whilst completing the objectives set out, it begs the question, was QE sufficiently streamlined and did BoE draw the right correlation between the unprecedently high excess savings ratio and effects of frequent government intervention (like Energy Price Guarantees), which prolonged the excess savings and contributed to persistently high core inflation.
Many economists compare US to UK inflation as an indicator as to whether the UK QE program was successful or not. The inflation rises are a good indicator of the net impact of the QE. It can be noted that initially, inflation rose much more aggressively in the US, before the rate hikes began around Mar 2022.
Both the Fed and BoE’s main course of action in combatting rising inflation was to tighten the monetary policy. The Fed started increasing interest rates in March 2022 vs BoE’s December 2021. However, despite being late to start rate hikes, the US rates had overtaken BoE rates by August 2022. The Fed aggressively increased interest rates to curb demand, and the BoE took a relatively slower approach. US inflation peaked at 9.06% (2% lower than the UK) and declined at a far quicker rate; by June 2023, US inflation had declined to 2.97%, whereas UK inflation was still at 7.9% (Y charts,2024)
It appears that the QE program pursued by BoE, while being excessive, and a contributor to stimulating demand, was at par with some of the other economic superpowers. However, the response to the increase in demand differed materially. It’s also important to note that household excess savings declined at a much slower rate in the UK compared to the US. Heavy government intervention during COVID and the energy crisis, facilitated by the BoE, limited the depletion of excess savings, facilitating aggregate demand and increasing the ability of manufacturers to pass price rises, fuelling persistently high core inflation. Faster and steeper rate hikes and less government intervention meant US excess savings depleted far quicker, controlling aggregate demand.
Pratham is a Year 12 student at the Manchester Grammar School, studying Maths Further Maths, Economics and Physics at A Level, hoping to pursue higher studies in Economics, with a particular interest in free markets and libertarianism.
Bibliography
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