Monetary policy in the UK: Further QE

Poor growth of the UK's economy and scarce market liquidity played a very important role in the Bank of England's decision to print £75bn more in QE,  because the exposure of British banks to toxic sovereign debt freezes up their ability to lend money to consumers and firms. In the Eurozone, Banks are facing the same “illiquid” problem, that led the European Central Bank decision to the same decision, pumping additional funds into European Banks.

In the UK, The central bank will buy back gilts (bonds issued by the British government) with residual maturities of over 3 years, thereby pumping liquidity in the economy, that will result in increased demand for borrowing, increased output, and depreciation of the pound sterling (thereby making the UK's exports cheaper and imports more expensive). Wonderful.

But what will the result be on the inflation rate? George Osborne agreed with the MPC that in the medium term further QE will help keep inflation on target. But economics teach us that prices depend on the quantity of the money supply. If there is an increase in the quantity of money supplied, prices will increase proportionately. In an economy with increasing inflation expected to rise further, in which the average household is experiencing very tough times, with almost no money left after necessary expenses, unemployment rising (7.9% in September) http://www.bbc.co.uk/news/business-14912236 and interest rates at an all-time low (still 0,5%) making savings an unattractive choice because of low yields, at first impact it doesn't seem that QE is the best way to restore wealth in the hands of consumers. 

If inflation rises real incomes will decrease even more, that will decrease demand, and it will really not matter if business's will be able to borrow as much as they did before because there will be less demand for their products. If consumer expenditure falls, unemployment will rise, a process we have been witnessing since the beginning of the crisis in 2008, as firms cut back on costs to cope with eventual losses. If unemployment rises, more people will not be able to pay back their mortgages which increased because of low interest rates.

The last thing I want to see is Mortgage crisis 2.

The vicious cycle

Interest rates in the uk are currently at an all-time low, currently at 0.5%.
http://www.bankofengland.co.uk/mfsd/iadb/Repo.asp

A future rise in interest rates both in the Eurozone and in the UK doesnt look very likely, after Merkel argued lately that there will be an additional cut on the ECB base rate should the economy worsen more than expected.
Since the recession started in 2008 there has been poor growth in output levels, inflation rates have been steadily rising above central bank's target (the consumer price index in the UK rose 4.5% in August), unemployment has been soaring as businesses desperately try to cut costs in the struggle to survive in these tough market conditions (tesco announced campaign to cut costs by 500M£ lately, for example) http://www.dailyrecord.co.uk/news/uk-world-news/2011/09/26/tesco-launches-freah-price-war-by-cutting-cost-of-3-000-products-as-part-of-500-million-campaign-86908-23447556/ due to consumer expediture steadily decreasing as households' real incomes decrease. At the same time the sovereign debt crisis started, influencing the UK because the EU is Britain's main commercial partner and because of the credit exposure that a lot of UK banks have on toxic European sovereign debt. You don't need to be an  econometrician to realize that the current financial situation is problematic and hasn't got any better since the recession started. For the moment there seem to be no signs that indicate the start of a recovery.


We know from physics that every body endeavours to preserve its current state (the inertia principle). This is one of the principles that governs the world and is also valid in economics, i.e. when an economy (or also a product) starts experiencing a trend, it tends to follow that trend unless it is influenced in some way by external factors.
This is exaclty what Merkel and other economic/political leaders have been trying to do.

They have been trying to influence the economy, by stimulating demand and trying to achieve growth, so that a new business cycle might start. But in order to have growth consumers real incomes need to rise, because only then they will have money to spend in the economy.

Paradoxically, under current market conditions consumers have seen their purchasing power diminished because of all the reasons stated previously. So how can this growth take place? It can't, I might argue. Not under current market conditions.

Low interest rates are one of the key aspects of the demand-boost policies that have been adopted so far. The objective of these policies is to stimulate demand and increase market competitiveness by providing businesses with cheap credit so that they might increase investments and expand their operations, employing more people. Because interest rates are low, consumers are more likely to save less and spend more, expecially given the ongoing increase in inflation. But how can they spend more if their real incomes decrease? Moreover, businesses will not want to invest with such low consumer confidence levels.

Seems to me like a vicious cycle.