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This article was written amidst the UK’s economic recovery period from the COVID19 pandemic and is centred around inflation concerns, as the UK is injecting money into the economy in an attempt to promote growth and maximise efficiency. The Bank of England is using quantitative easing, where the money supply is increased to encourage spending in the economy. The UK is achieving this through solutions such as purchasing bonds and injecting cash into debt markets. In times where the government may want to boost spending, they may buy government bonds from commercial banks, who besides their established reserve requirements, possess excess reserves for loans. The funds which commercial banks receive for the sold bonds are used as excess reserves, and more can be loaned out, which in turn increases spending. The interest rates are further lowered in the long run, and the supply of money circulating in the economy increases. This is illustrated in graph 1 below.
Illustrated in the above diagram is the supply and demand for money in an economy. The downwards sloping demand curve D depends on the relationship between the quantity of money, and the rate of interest. As the interest rate decreases, the quantity of money demanded in the economy increases accordingly. The fixed and perfectly inelastic supply curve is independent of the interest rates, and Sm and Dm curves together form the equilibrium a, and interest rate r. In the case where the central bank decides to use quantitative easing to boost spending in the economy, they may buy government bonds from other financial institutions on a large-scale, in exchange for cash, resulting in the bond price going up. As there is more money being lent out and circulating in the economy, the supply of money shifts from Sm to Sm1. This results in a move along the Dm demand curve, and the new equilibrium point b establishes a lower interest rate. This in turn allows for even more spending, and the interest rate is eventually pulled down until the central bank reaches its goal rate.
There are concerns surrounding the inflationary outcome of the UK's quantitative easing program, considering the inflation rate that has already surpassed the goal for 2021. If inflation is paired with an increase in output, the positives associated with maximising employment of labour and resources may outweigh the negatives. However, this is under the assumption that inflation will further occur in the UK’s current economic state. Consumers may become more hesitant to spend more because of the high unemployment rates, and tend to save money instead (an effect of low consumer confidence). Considering that the propensity to consume is lower, inflation may not further occur. Furthermore, the low interest rate accredited to quantitative easing may reduce the UK’s budget deficit and ameliorate crowding out issues.
However, if quantitative easing were to cause higher inflation, there may be a risk of stagflation. Stagflation is where a reduction in aggregate supply creates higher price levels and lower output. The UK has suffered sudden high unemployment rates and slow growth, suggesting a presence of stagflation. However, QE, despite its aim of stimulating economic growth and promoting spending, may be exacerbating the issue, as the economy may respond by raising price levels, despite unprofitable production and unemployment as a result. As stagflation can be difficult to control and extremely damaging to any economy, it is important for the UK to primarily aim for low inflation rates.
Another issue associated with QE in a recession is that it may disproportionately benefit the wealthy, and work primarily in the favour of commercial banks. As bond and asset prices increase, commercial banks have been able to sell them for higher prices and increase reserves. In addition, due to the rise in asset prices, the wealthier members of society who own the majority of them are further benefited (the wealth effect). This raises the issue of equity and income inequality, and becomes a distribution efficiency problem. A result of the expected fall in unemployment is the increase in tax revenue to the government (and despite this reducing their budget deficits, middle to lower-class households will be paying a larger proportion of their income on taxes, and will therefore be more affected than wealthier households owning assets). Those on fixed incomes (like pensioners and government employees) will not be able to match the further increase in general income resulting from higher inflation rates. The disadvantages these members of society face can be accredited to time lags that arise from monetary policy
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