US Follows UK Approach To Quantitative Easing

In response to interest rates approaching zero both the UK and the US have embarked on a process of quantitative easing, the modern equivalent of printing money to try and drive economic growth. In most circumstances increasing the money supply in this way needs to be done very carefully, as it can lead to inflation and a decrease in the value of a country’s currency. In this situation however, with deflation a much more realistic threat and interest rate reductions failing to drive needed growth, this approach has been deemed worth the risk for the time being.

The approach being taken is to generate money that the central bank, in the case of the US the Federal Reserve, and in the case of UK the Bank of England, use to purchase various forms of debt. As of today the US Fed has decided to follow the approach taken by the Bank of England and start purchasing government issued bonds. The goal of this exercise is to drive down interest rates on this government debt, due to the price of these bonds rising based on increased demand. Hopefully we will then see a similar effect happen in other areas of debt issuance. Up until today the US Fed had chosen not to go down this route. Instead it had chosen to invest in multiple types of commercial debt, the goal being to kick start the flow of lending in this area more directly. This path will continue and will now be complimented with government debt purchases. There will also be an expansion of planned purchases of mortgage backed securities.

Interestingly the US benefits greatly from being a safe haven reserve currency, especially in these troubled times. Despite the huge amount of debt the US plans to issue, the safety of US bonds continues to allow the US government to gain financing at relatively low rates. The dollar has gained considerably in value because of this status. It seems however that the Fed feels we have reached the time to pull out all the stops, so has opened up another front in the battle to revive growth.

The UK is similarly hoping that money flowing into the system through the purchase of UK government debt, will translate into additional lending and generally lower interest rates. It has not embarked on purchasing commercial debt directly as in the US, but could do so in the future. You also have to wonder if the decision by the US to purchase its own debt will put some pressure on the effectiveness of the UK scheme.

At the end of the day we will need to wait and see how effective this all is. Quantitative easing was used by Japan during the period of their “Lost Decade” and there is debate as to the effectiveness of this. Only time will tell how effective it will be for the US and UK.