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Printing money won’t solve all our problems

Quantitative easing is the latest economic catchphrase to get to grips with, and unless you have an in-depth knowledge of Japanese economics in the past decade it’s unlikely to be a term you are familiar with.

But it’s something we will be hearing a lot more of in the coming months, as the Bank of England takes drastic steps to ease conditions in the credit markets and breathe fresh life into lending and spending.

By creating more money, the Buying government bonds from banks should increase the cost of these so their yield – or return – should fall.

This fall in yield will help to lower long-term interest rates, making five and 10-year fixed rate mortgages more attractive.

But in the context of the mortgage market, what we want to know is simple – will quantitative easing make lenders more willing to lend or will they simply hoard their money as they have done until now?

So in principle, quantitative easing should boost the money supply but in these times of economic turmoil banks could simply sit on the cash.

This is what happened in Japan in 2001 when the government used quantitative easing to drag the economy out of a decade-long deflationary spiral. Banks held on to the extra money they received, making the process ineffective.

And even if banks increase their lending there is no guarantee it will go to those who need it most. They may prefer consumers who can already access money, meaning the market sees even more mortgages available at 60% LTV and continuing lack of choice at 90% LTV.

While this will be good news for those with hefty deposits or plenty of equity in their homes it will be of limited use to struggling first-time buyers.

To ensure banks don’t hoard their cash, quantitative easing should be carried out alongside recapitalisation of the banking system.

The government must also closely monitor banks to ensure they are genuinely lending and not just making the right noises.

So even if quantitative easing helps resolve some short-term liquidity problems, other fundamental issues in the system must be addressed.

These include the underwriting of systemic financial risks, the recapitalisation of banks and turning up the regulatory pressure to force lenders to disclose their toxic debt.

Permanent solutions to resolve structural problems in the banking system are crucial. Without them, the current strategy of quantitative easing will be ineffective, as it was in Japan.

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