Macroeconomics For Dummies - UK
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The UK, like the US, undertook a substantial amount of quantitative easing (QE) over the past few years. Quantitative easing involves creating large amounts of electronic money and then using it to purchase mainly government bonds. By doing so the central bank increases the amount of money in circulation.

Over the years, the Bank of England has acquired around £375 billion worth of UK government bonds due to quantitative easing. This is an absolutely phenomenal amount of money and a large chunk of total UK government debt.

An interesting question is: why doesn’t the Bank of England ‒ now that it owns these bonds ‒ just say to the government, ‘Don’t worry, you needn’t pay the money back’?

After all, the Bank of England is ultimately under the control of the UK government (even though it’s operationally independent), and the Bank can just create money for free if it ever needs it. So why not, in one fell swoop, just eliminate a large proportion of debt, which otherwise taxpayers will have to pay?

Here are the reasons:

  • Doing so would be the equivalent to the government funding itself in a big way by seigniorage (printing money), and all the hyperinflations of the past (Germany, Zimbabwe and so on) were caused by the government printing money to fund itself.

  • Doing so would mean that the monetary policy and fiscal policy were really one and the same with potentially devastating consequences. Think about it this way: politicians would know that overspending didn’t really matter, because at some point in the future the debt would be written off. The result would be a soft budget constraint ‒ that is, governments would no longer feel that they have to satisfy their intertemporal (across time) budget constraint and would consistently overspend.

  • Financial markets would understand the government’s soft budget and expect them to overspend and eventually get the debts written off. This would increase inflation expectations, which would increase actual inflation. The interest rate that the government would have to pay to borrow would rocket as investors realised that they’d likely be paid back using seigniorage. The pound would lose much of its value versus other currencies, because of the risk that seigniorage was here to stay.

About This Article

This article is from the book:

About the book authors:

Manzur Rashid, PhD, is a Lecturer of economics at University College, London. Peter Antonioni is a senior teaching fellow at the Department of Management Science and Innovation, University College, London, and coauthor of Economics For Dummies, 2nd UK Edition.

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