Quantitative Easing for Dummies

Let’s say I have £5, I need five loaves of bread and bread is the only thing I ever buy. You are a baker and you have 5 loaves of bread to sell. You know that I have £5 and that I want five loaves of bread. Result? You charge me a £1 a loaf and sell all five loaves. You then go and spend that £5 elsewhere.

Now, pretend that I am not just a private individual but the government. I print another £5 but I tell you that I’ve done so. I then come to you and want to buy 5 loaves of bread. Because I’ve told you that I’ve printed an extra £5 you know that I hold £10 in my hand. Result? You double your prices and charge me £2 a loaf. You now have £10, but when you go to the fishmongers to buy fish, she knows that you’ve got twice as much money from me than normal. Result? She doubles her prices. And when the fishmonger goes to the butcher with the £10 she’s taken, he doubles his prices.

Nothing new gets made and everything costs more than before. And for those people on fixed incomes, they can only buy half as much.

Douglas Carswell knows this, John Redwood knows this, loads of other MPs know this. But the Government?

It’s true – Quantitative Easing is for Dummies.

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4 Comments on “Quantitative Easing for Dummies

  1. This is not adequate. The point is that you don’t know, and that money, although it has nothing other than derived value from goods and services, has a price. In the situation in which we find ourselves, the drop in the price of money has not had an effect on the shrinking quantity of money (which includes its velocity). So as a result the bank is doing what it intends its 0.5% interest rate to do, not reflected in the banking system’s activities.

    At this end of the economic cycle, and in its depth, monetary policy is coming to a point of little impact. You could issue all the money in the world, and if it is not used, it just adds to passive savings. This is why the monetarist logic breaks down, and the Keynesian logic takes over. That is that there needs to be actual spending on activities by government that employs spare resources.

    The danger comes when there is uplift in the economy and all the money swilling around then becomes inflationary. The danger is that such an uplift is seen as recovery. Recovery ought to be supply based, that is spending on projects by government that adds value or gives potential to add value. The government is not doing anything like enough of this.

    The economy has multipliers and accelerators and it is not a simple sum of double money equals double prices. It has to take into account resource use and lack of use.

  2. The big flaw in the above article is that despite QE, the money supply just hasn’t increased significantly. Indeed, the whole point of QE is to print money so as to make up for the near catastrophic collapse in commercial bank created money (caused by deleveraging and people becoming more thrifty – Keynes “paradox of thrift”). Money, on most measures, has been expanding at less than half the rate recently compared the rate around 2004 and 2005 (when there was no QE!)

    A valid criticism of the point in the above para is that QE creates monetary base or “high powered money” as it is sometimes called (i.e. central bank created money). This is arguably more potent stuff than commercial bank created money. There is certainly something in this criticism, and to take account of it, central banks may well rein in some of the money they have created if excess inflation looms.

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