“Quantitative easing is a term used to describe the situation when the central bank creates new money out of ‘thin air’ and injects it into the banking system. This is done to increase the cash deposits banks have which in turn will enable them to start lending again therefore increasing the money supply.
“There are three main ways of reducing the pressure on the banks: buy government bonds to reduce interest yields; by lending to the banks directly; or by buying assets from banks in exchange for money to reduce inter-bank overnight interest rates to encourage banks to loan money to higher interest rate paying companies and individuals.
“Japan implemented such a policy in early part of this decade to combat deflation. During this time it bought more government debt to maintain a 0% interest rate as well as asset backed securities and equities.
“It is generally accepted that we are heading into a period of deflation, prices are falling rapidly; RPI is just 0.1% (from 5% in October). Deflation is a sustained fall in general prices once inflation has passed zero. For consumers this basically gives them the choice of waiting before making a purchase - after all if prices are falling, that TV you wanted will be cheaper in a month’s time. So the solution is seen to be quantitative easing.
“The biggest concern is that in the future the creating of large sums of money out of nothing will produce a period of high inflation.”
