Satyajit Das: They are all at it – but side effects of QE may turn out to be highly toxic

Midweek View: Inflation cuts the value of debt. It also induces consumer spending, as people accelerate purchases

The Bank of England is doing it again. The US Federal Reserve may do it again. The Bank of Japan has been doing it for a long time. Even the Europeans are now doing it, secretly. It is quantitative easing (QE), sometimes parsed as "printing money".

With interest rates low, central banks are changing the quantity of money by buying government bonds, injecting cash into the banking system. In theory, QE lowers borrowing costs and creates liquidity, hopefully stimulating demand and inflation.

But lower rates and increasing the supply of money, of themselves, may not boost economic activity.

Crippled by high levels of debt, low house prices, uncertain employment prospects and stagnant income, household are reducing, not increasing, borrowing.

For companies, the absence of demand and, in some cases, excess capacity, means that low interest rates are unlikely to encourage borrowing and investment.

QE has primarily boosted asset values, subsidised banks, weakened the

currency and helped the Government finance its deficit.

Lower interest rates and central bank buying help boost the value of

financial securities. It increases the attractiveness of financial assets producing higher income, such as dividend-paying stocks or corporate debt.

The effect of QE on real economic activity through higher asset prices is based on the wealth effect, whereby people are likely to spend or borrow more when their investments are worth more.

QE provides discreet subsidies to banks in the short run. Lower rates reduce the cost of deposits, which can then be reinvested in low-risk government bonds at a substantial profit. But QE ultimately pushes down yield on bonds reducing returns, decreasing the net interest margin and profits earned by banks.

QE weakens the currency, improving export competitiveness. It reduces the value of a country's debt which can be paid back in devalued paper money.

But it does not work if everyone tries to do it simultaneously. In the relative game of currencies, every nation cannot have the cheapest money.

The ability of QE to generate rising prices relies on the economist Milton Friedman's observation that "inflation is always and everywhere a monetary phenomenon".

Inflation cuts the value of debt. It also induces consumer spending, as people accelerate purchases, anticipating higher prices in the future. But QE's ability to create inflation is doubtful, at least in the short run.

Unfortunately, the transmission mechanism, the banking system, is broken. The velocity of money or the rate of circulation has slowed, offsetting the effect of QE.

The lack of demand due to weak consumption, lacklustre investment and now government austerity, and excess productive capacity in many industries also means low inflation.

Most developed economies have an "output gap", with total demand well below the economy's potential to produce goods.

QE also creates problems for emerging markets and commodity prices. Low interest rates and falling currency values have encouraged investors to increase investments in emerging markets, offering better returns and more encouraging growth prospects. Much of the capital flows into emerging markets are short term. A rapid withdrawal of this money could be highly destabilising, as evidenced by the Asian crisis of 1997/1998.

As most commodities are priced and traded in US dollars, the lower value of the currency causes commodity price rises. In addition, low interest rates encourage speculation in and stockpiling of commodities.

Higher commodity prices and strong capital flows fuel inflation in emerging markets. Given that emerging markets have been a key driver of the tepid comeback of economic activity globally, this risks truncating the recovery.

The side effects of QE may prove highly toxic, in part because of the risk

of retaliation from affected parties. Emerging market countries are openly talking about "currency wars". Some have already introduced controls against short-term capital flows. Such measures could affect the prospects of global economy recovery.

QE resembles fetishes, objects believed to have supernatural powers.

Despite evidence to the contrary, these financial fetishes are predicated on the belief that the theories and models are correct, policymakers know what they are doing and the actions will be effective.

Satyajit Das is author of 'Extreme Money: The Masters of the Universe and the Cult of Risk'

Alan Bennett criticised the lack of fairness in British society encapsulated by the private school system
peopleBut he does like Stewart Lee
Former Governor of Alaska Sarah Palin, left, with her daughter, Bristol
newsShe's 'proud' of eldest daughter, who 'punched host in the face'
David Moyes and Louis van Gaal
Arts and Entertainment
Sheridan Smith as Cilla Black and Ed Stoppard as her manager Brian Epstein
tvCilla Episode 2 review: Grit under the glamour in part two of biopic series starring Sheridan Smith
Life and Style
Vote with your wallet: the app can help shoppers feel more informed about items on sale
lifeNew app reveals political leanings of food companies
Arts and Entertainment
The cover of Dark Side of the Moon
musicCan 'The Endless River' carry on the tradition? See for yourself
New Zealand fly-half Aaron Cruden pictured in The Zookeeper's Son on a late-night drinking session
A new app has been launched that enables people to have a cuddle from a stranger
voicesMaybe the new app will make it more normal to reach out to strangers
Arts and Entertainment
Salmond told a Scottish television chat show in 2001that he would also sit in front of a mirror and say things like,
tvCelebrity Trekkies from Alex Salmond to Barack Obama
ebooksAn unforgettable anthology of contemporary reportage
Life and Style
food + drink
Rob Merrick's Lobby Journalists were playing Ed Balls' Labour Party MPs. The match is an annual event which takes place ahead of the opening of the party conference
newsRob Merrick insistes 'Ed will be hurting much more than me'
A cabin crew member photographed the devastation after one flight
Life and Style
Carol O'Brien, whose son Rob suffered many years of depression
healthOne mother's story of how London charity Maytree helped her son with his depression
Life and Style
The Google Doodle celebrating the start of the first day of autumn, 2014.
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Trainee / Experienced Recruitment Consultants

£20000 - £25000 per annum + OTE £40,000: SThree: SThree are a global FTSE 250 ...

Trainee Recruitment Consultant - Soho

£20000 - £25000 per annum + OTE £40000: SThree: As a Recruitment Consultant, y...

Trainee Recruitment Consultants - Banking & Finance

£20000 - £25000 per annum + OTE £40,000: SThree: SThree Group have been well e...

Quantitative Risk Manager

Up to £80000: Saxton Leigh: My client, a large commodities broker, is looking ...

Day In a Page

Secret politics of the weekly shop

The politics of the weekly shop

New app reveals political leanings of food companies
Beam me up, Scottie!

Beam me up, Scottie!

Celebrity Trekkies from Alex Salmond to Barack Obama
Beware Wet Paint: The ICA's latest ambitious exhibition

Beware Wet Paint

The ICA's latest ambitious exhibition
Pink Floyd have produced some of rock's greatest ever album covers

Pink Floyd have produced some of rock's greatest ever album covers

Can 'The Endless River' carry on the tradition?
Sanctuary for the suicidal

Sanctuary for the suicidal

One mother's story of how London charity Maytree helped her son with his depression
A roller-coaster tale from the 'voice of a generation'

Not That Kind of Girl:

A roller-coaster tale from 'voice of a generation' Lena Dunham
London is not bedlam or a cradle of vice. In fact it, as much as anywhere, deserves independence

London is not bedlam or a cradle of vice

In fact it, as much as anywhere, deserves independence
Vivienne Westwood 'didn’t want' relationship with Malcolm McLaren

Vivienne Westwood 'didn’t want' relationship with McLaren

Designer 'felt pressured' into going out with Sex Pistols manager
Jourdan Dunn: Model mother

Model mother

Jordan Dunn became one of the best-paid models in the world
Apple still coolest brand – despite U2 PR disaster

Apple still the coolest brand

Despite PR disaster of free U2 album
Scottish referendum: The Yes vote was the love that dared speak its name, but it was not to be

Despite the result, this is the end of the status quo

Boyd Tonkin on the fall-out from the Scottish referendum
Manolo Blahnik: The high priest of heels talks flats, Englishness, and why he loves Mary Beard

Manolo Blahnik: Flats, Englishness, and Mary Beard

The shoe designer who has been dubbed 'the patron saint of the stiletto'
The Beatles biographer reveals exclusive original manuscripts of some of the best pop songs ever written

Scrambled eggs and LSD

Behind The Beatles' lyrics - thanks to Hunter Davis's original manuscript copies
'Normcore' fashion: Blending in is the new standing out in latest catwalk non-trend

'Normcore': Blending in is the new standing out

Just when fashion was in grave danger of running out of trends, it only went and invented the non-trend. Rebecca Gonsalves investigates
Dance’s new leading ladies fight back: How female vocalists are now writing their own hits

New leading ladies of dance fight back

How female vocalists are now writing their own hits