The Bank of England recently announced a £75bn cash injection into the economy. Why? It is to boost the economy by pushing up demand. Since the interest rate is already set to a low, this is another way to have a long term effect at ensuring the interest rate stays low. How does this boost the economy? When interest rates are low, borrowing from banks will be cheaper, mortgages will be less of a pain to settle and household savers will be discouraged to save and will spend it instead. The latter has a negative side to it really but the main point here is to spend and spend so the economy can balloon up with cash.
How does it work? Currently, the Bank of England will buy bonds or gilts from banks. From basic economics, a high demand in bonds will increase the price. There is an inverse relationship between price of bonds and the yield or interest rate earned on the bond. Hence, a high price will drive down the interest rate. Since borrowing, saving and mortgage interest rates depend strongly on the interest rates on bonds or gilts, this will mean the interest rates will be sustained at a low amount. This is however the long term effect.
In a shorter effect, more cash for banks will mean there will be enough lending at a considerably low interest rate. Putting cash in the hands of banks and people will mean there will be more demand for assets. When this happens, the economy takes a turn for the better.
More to read from the link below, which leads to an article by theguardian comprising of important aspects and critical analysis of this economic policy.
Read more:
http://www.guardian.co.uk/business/2011/oct/07/quantitative-easing-what-is-it
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