Quantitative easing explained

In these worrying economic times the official authorities (made up of governments and the central banks) have done much to try to stimulate their anaemic economies. We have seen the governments act with several fiscal stimulus packages with a combination of higher official spending and lower taxes. At the same time the central banks have cut short-term interest rates to record lows. In the latest case the European Central Bank cut their main rate to just 2% last week. Sadly despite these measures the world economy looks to be on the verge of a deeply worrying meltdown. As a result the authorities are now considering yet more desperate measures. One of these is called quantitative easing. So what does this mean?

To put it simply the central bank injects extra money into the economy as a means of expanding the money supply. This is normally done through the process of the central bank acting to buy various types of government securities in the international bond market. The intention of this activity is to drive down the rate of longer-term interest rates to match the reductions already made in short-term rates. You should remember that the interest rate on the bond (or yield as it is normally called) goes down as the price increases in response to the extra government-induced demand for these securities. This would also tend to cause other long-term interest rates to fall including some mortgage rates and most importantly the corporate lending rates. In addition the banks will end up with extra cash resources to lend to either individuals or companies as they swap their bonds for cash which they receive from the central banks.

The downside of this policy is the risk that it can be seen to be increasing inflationary pressures especialy when the economic activity eventually picks up again. At the moment this looks like a risk that the authorities will be prepared to take.

If you go to see my latest blog for "Reading and Understanding the Financial Times" I will tell you more about this policy tool.

The fall and fall of UK House Prices

According to the latest survey by the Nationwide Building Society UK house prices fell by nearly 16% in 2008. As a result the average price has now hit a little over £153,000. This time last year most economists had expected some fall in house prices in the coming year. However, it should be said that the actual reduction has been far more dramatic than anticipated. The main reason for this development has been the change in the availability of mortgages. Gone are the days when banks and building societies lent money with almost no regard to the ability of the households to repay their debts. We have gone back to the pattern of the 1970s when lenders have to beg financial institutions for new mortgage funds. With the lack of available funds the demand for houses has collapsed. These tighter lending conditions look set to remain in place for much of 2009. In addition with more and more people being made redundant on a daily basis it is hard to see any confidence returning to the UK housing market in the foreseeable future.

You can access information on this house price data if you follow this link...

http://www.nationwide.co.uk/hpi/