Bank begins using 'new' money

Published 12th Mar 2009

The Bank of England has launched its latest attempt to boost the supply of credit and stimulate the UK economy, using £75bn it has, in effect, created.

It has bought £2bn of government bonds from financial institutions and funds, in the first of a series of auctions designed to help troubled banks.

The aim is to get the Bank's newly created cash out into the wider economy and encourage greater lending.

The Bank said last week it would pump £75bn into the economy.


HOW THE BANK CREATES MONEY
Bank expands money supply by using newly created money to buy assets from banks
Aims to boost the economy by giving sellers of these assets money to spend on goods, services or more assets
Bank starts by using £2bn of newly created money to purchase government bonds
Size and type of its weekly purchases announced on Thursdays
Two auctions to be held every week on Mondays and Wednesdays
Results announced immediately
£75bn of new money to be spent in first three months


Using a reverse auction, the Bank bought just under £2bn of the bonds, known as gilts.

The amount of offers the Bank received from commercial banks was about £10.5bn, meaning that financial institutions wanted to sell five times more debt than the Bank had offered to buy.

Similar auctions will continue twice weekly.

'Triumph'

The policy, known as quantitative easing, has never been tried previously in the UK.

The hope is that those who sell the government bonds will use the money from the Bank to lend to individuals or companies or invest in business activity.

The prices of long-term government bonds, or gilts, have surged 20% over the last few days in anticipation, which has resulted in yields on the benchmark 10-year bond dropping to a record low.

The BBC's business editor Robert Peston said the drop in the cost of borrowing appeared to be a "triumph" for the Treasury, which has to sell over £100bn a year of new government debt to finance its budget deficit.

"The device of authorising the Bank of England to buy up a huge proportion of these IOUs [the government bonds] has apparently reduced the cost of all that borrowing to an astonishing degree," Mr Peston said.

Deflation

These actions are unprecedented in the Bank's 315-year history, but are now considered necessary as interest rates approach zero and deflation becomes a growing possibility.

It has government permission to inject a further £75bn into the economy if it wishes, after slashing interest rates to a record low of 0.5% to boost the UK economy, which has entered a recession.

Deflation - or falling prices - is bad for the economy as it encourages consumers to delay spending in the expectation that prices will soon be lower, potentially worsening an economic downturn.

The governor of the Bank of England, Mervyn King, has admitted he does not know how long quantitative easing will take to have an effect but says it will "eventually work".

Source: ' BBC '

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