The Bank of England and its monetary-policy committee (MPC), under the guidance of governor Sir Mervyn King, has just pumped a further £75 billion into the British banking system via an unconventional process known as quantitative easing (QE). But how effective will this be at kick-starting our economy and how much of this money will filter down into the real economy?
This newly created (electronic) money has been used to buy government bonds (gilts). The theory is that by taking a percentage of safe securities off the market, investors and high street banks will seek riskier investments. Instead of owning low yield gilts, high street banks should then seek higher yields by lending money to businesses and first-time buyers. Investors will turn to corporate bonds and stocks, which in turn will encourage big business to stop hoarding cash and spend more. Overall, the hope is this will increase the supply of money in the economy.
Although opinion is largely divided on the success of the first round of QE in 2009-10, when the Bank bought £200 billion of bonds, the Bank’s own analysis suggests it boosted GDP by 1.5-2%. Many economists believe that this growth was largely a result of lowering yields on gilts. The problem is that yields on 10-year gilts now stand at 2.5%, which is a 50-year low and half what they were in 2009. They clearly have less scope to fall and therefore less potential impact on growth. And with inflation set to rise above 5% in November, surely there is a different way, a different kind of easing required.
Small and medium-sized enterprises (SMEs) account for over half of UK GDP, according to the Federation of Small Businesses, and yet we have experienced a near three year slump in lending. To hope that this latest round of QE will improve access to finance for this vital and fund-starved sector of the economy I believe is foolhardy. The chancellor, George Osborne, has asked the Treasury to explore options for improving the situation but we’re lacking decisive action. David Smith, an economics columnist for The Sunday Times, is adamant that the economy is receiving the wrong kind of easing. Mr Smith advocates ‘credit easing’ which would see the Bank buy up bundles of SME loans and boost the flow of credit to a sector of the economy that has massive growth potential. Adam Posen, an MPC member, also believes that part of the economy’s weakness is down to a shortfall in SME credit provision. He advocates a state-backed SME bank to meet the funding shortfall that he puts at some £30 billion. We need brave, bold and decisive action to kick-start our economy and I for one believe in the growth potential of SMEs in the UK. If this country has any hope of nurturing tomorrow’s big business we have to start today with the small guys.
