Page last updated at 14:15 GMT, Thursday, 5 November 2009

Can stimulus cure the ailing economy?

Analysis
By Nils Blythe
Business correspondent, BBC News

Quantitative easing is an experiment.

Generic docture with patient
Curing economic problems is not easy

In some ways it is like using a new drug on a sick patient.

The treatment was started in March. It has not killed the patient. Nor has the patient been suddenly cured.

And the doctors of the Monetary Policy Committee have to decide whether to keep giving the drug.

They have opted to keep on with the treatment, but at a lower dosage.

Creating a further £25bn of new money over the next three months is a significant reduction in a programme that has been running at an average of £17bn per month.

So how will the bank know if the treatment is working?

The best proof would be a recovering economy. It has not yet returned to growth, according to the figures for the third quarter of the year from the Office for National Statistics.

But the Bank of England says that "a pickup in economic activity may soon be evident".

Is it working?

Nonetheless, the Bank says it expects the recovery to be "slow". Hence the decision to keep applying the stimulus of creating new money.

As the Bank freely acknowledges, economic recovery will not prove that quantitative easing (QE) has worked.

Economies are often resilient and bounce back after recessions.

There is no parallel universe with a UK economy that has not had the QE treatment with which we can make a comparison.

It is fairly clear that QE has had an impact in one area.

The Bank of England has used the newly created money to buy UK government bonds in huge amounts. That has helped to push down long-term interest rates in the financial markets.

Those lower long-term market rates should in in turn help keep down the cost of borrowing for businesses and home-owners.

But lenders are simultaneously trying to rebuild their profits and balance sheets.

So the benefits in terms of borrowing for many people are defined in terms of "think how much worse it might be without QE".

New bubble?

The biggest concern about QE is that it may have nasty side-effects.

Because the Bank of England has been buying bonds from big investors they have money to spend on other assets.

Many observers believe that a lot of the money has gone into buying shares.

The concern that many people in the financial world, or City of London, express is that the summer rally in share prices was partly a consequence of QE.

A rally in share prices is usually welcome - not least to pension funds.

But if that rally is based not on fundamentals such as the prospect of better corporate profits, but on an experimental monetary policy, it begins to look suspiciously like a bubble.

And we are still clearing up from the bursting of the last bubble.



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