[Mbob]

(Original post by TheHansa)
Why does the government allow more money to be printed to give to banks to allow them to either play the IB game or use to give people loans when instead it could print the money and give an equal amount to everyone on the electoral register or something? This way people would not have to go into debt to get more money and it could be used by normal people to either pay back debt, buy things or invest. I always thought it would be a dumb idea but recently on bbcnews.co.uk some guy in a suit said it could work and the only reason it isn't given the go ahead is because the government doesn't want people to get used to the idea of getting money for nothing.

The government has not just 'given' money to the banks - that's just a lazy way of expressing things used by the media and most other people.

The Bank of England has 'created' money which it has then used to buy government bonds (i.e. government debts) from banks. Banks have no more money than before - they've just exchanged a non-liquid asset - the bonds - for liquid cash. In theory, this then makes it more likely that they will lend that money to businesses or individuals - increasing the rate of flow of money within the economy.

Of course the Bank of England now has government bonds where it had nothing before. There has been an increase in the total money supply (i.e. the total value of everything) and so this generally causes inflation.

However, inflation is a bit more complicated than that. Inflation does not arise just because there is more money circulating, it also depends on what the expectation of future inflation is. The Bank of England has promised that, in the future, it will sell these bonds back onto the market and then 'destroy' the money it receives for them. This should either cause deflation to match the inflation caused earlier or, if the inflation never happened because people had allowed for this re-purchase, it will change nothing.

So the total effect of quantitative easing, in theory at least, is that there is no long term effect on inflation. In practice it may not work out like that. But the effect of just giving money to people, while it may cause an immediate economic boost, would almost certainly cause inflation and hence erode the value of people's savings. Economic effects aside, there is a definite amount of moral hazard involved in this. And, unlike in quantiative easing, there would be no obvious way to 'undo' the inflation, since the BoE/government has not received any assets in exhange for the cash.

A more interesting question is this. If quantitative easing does cause a temporary spike in inflation but inflation then fall to very low levels, what does the Bank of England do? Sellings its bonds might cause deflation - generally a very bad thing. So it could just write off the bonds - i.e. cancel a big chunk of the government's debt! Unlikely, but not impossible.

[Classical Liberal]

(Original post by Mbob)
The government has not just 'given' money to the banks - that's just a lazy way of expressing things used by the media and most other people.

The Bank of England has 'created' money which it has then used to buy government bonds (i.e. government debts) from banks. Banks have no more money than before - they've just exchanged a non-liquid asset - the bonds - for liquid cash. In theory, this then makes it more likely that they will lend that money to businesses or individuals - increasing the rate of flow of money within the economy.

Of course the Bank of England now has government bonds where it had nothing before. There has been an increase in the total money supply (i.e. the total value of everything) and so this generally causes inflation.

However, inflation is a bit more complicated than that. Inflation does not arise just because there is more money circulating, it also depends on what the expectation of future inflation is. The Bank of England has promised that, in the future, it will sell these bonds back onto the market and then 'destroy' the money it receives for them. This should either cause deflation to match the inflation caused earlier or, if the inflation never happened because people had allowed for this re-purchase, it will change nothing.

So the total effect of quantitative easing, in theory at least, is that there is no long term effect on inflation. In practice it may not work out like that. But the effect of just giving money to people, while it may cause an immediate economic boost, would almost certainly cause inflation and hence erode the value of people's savings. Economic effects aside, there is a definite amount of moral hazard involved in this. And, unlike in quantiative easing, there would be no obvious way to 'undo' the inflation, since the BoE/government has not received any assets in exhange for the cash.

A more interesting question is this. If quantitative easing does cause a temporary spike in inflation but inflation then fall to very low levels, what does the Bank of England do? Sellings its bonds might cause deflation - generally a very bad thing. So it could just write off the bonds - i.e. cancel a big chunk of the government's debt! Unlikely, but not impossible.

Very close.

What you have missed out is that the BoE creates central bank money and exchanges it for government bonds. This central bank money is not the same as the money in your bank account, which is commercial bank money (which is basically debt).

Central bank money is just money that the banks exchange with each other (they do not lend it out).

Suppose Dave banks with HSBC. The car dealer banks with Santander. Dave buys a £10,000 car from the dealer. The balance in Dave's account falls by £10,000. HSBC then sends £10,000 of central bank money to Santander. And Santander credits the dealers account with £10,000.

The only exchange of anything real was the central bank money between the banks. Otherwise it was just typing numbers into an account.

All the adding central bank money to the banking system, QE, does is to make it easier for banks to exhange with each other. It just makes the banking system more liquid. It makes the banks trust each other more, because the banks believe that other banks will have the central bank money to pay for any deficits they incur.

However, adding central bank money arguably has no effect on the actual money supply, namely commercial bank money (money created when people take out loans, debt). Just because a bank has more central bank money, does not mean it think that debtors will pay their debts and it does not people want to go into debt.

Arguably QE has absolutely no effect on the economy beyond lowering government borrowing costs (except when banks refuse to lend to each other - a credit crunch, which is not the problem at the moment), because it reduces the supply of bonds and increases the demand for bonds.

[Mbob]

(Original post by Classical Liberal)
Very close.

What you have missed out is that the BoE creates central bank money and exchanges it for government bonds. This central bank money is not the same as the money in your bank account, which is commercial bank money (which is basically debt).

Central bank money is just money that the banks exchange with each other (they do not lend it out).

Suppose Dave banks with HSBC. The car dealer banks with Santander. Dave buys a £10,000 car from the dealer. The balance in Dave's account falls by £10,000. HSBC then sends £10,000 of central bank money to Santander. And Santander credits the dealers account with £10,000.

The only exchange of anything real was the central bank money between the banks. Otherwise it was just typing numbers into an account.

All the adding central bank money to the banking system, QE, does is to make it easier for banks to exhange with each other. It just makes the banking system more liquid. It makes the banks trust each other more, because the banks believe that other banks will have the central bank money to pay for any deficits they incur.

However, adding central bank money arguably has no effect on the actual money supply, namely commercial bank money (money created when people take out loans, debt). Just because a bank has more central bank money, does not mean it think that debtors will pay their debts and it does not people want to go into debt.

Arguably QE has absolutely no effect on the economy beyond lowering government borrowing costs (except when banks refuse to lend to each other - a credit crunch, which is not the problem at the moment), because it reduces the supply of bonds and increases the demand for bonds.

Thanks, I kind of realised that it was a question of creating 'reserves' rather than real money, but that was nicely explained.

My understanding of why quantiative easing would help with lending is that banks are currently sitting on cash in case they have to absorb losses on their current loan book (plus Basel). This might stop them lending money even to poeple they consider low risk because they are concerned about their liquidity. Opinions seems to be pretty mixed among economists though.

[Classical Liberal]

(Original post by Mbob)
Thanks, I kind of realised that it was a question of creating 'reserves' rather than real money, but that was nicely explained.

My understanding of why quantiative easing would help with lending is that banks are currently sitting on cash in case they have to absorb losses on their current loan book (plus Basel). This might stop them lending money even to poeple they consider low risk because they are concerned about their liquidity. Opinions seems to be pretty mixed among economists though.

I think you might be reffering to capital adequacy ratios. Which are different thing to reserve ratios.

[MagicNMedicine]

(Original post by Mbob)
T
A more interesting question is this. If quantitative easing does cause a temporary spike in inflation but inflation then fall to very low levels, what does the Bank of England do? Sellings its bonds might cause deflation - generally a very bad thing. So it could just write off the bonds - i.e. cancel a big chunk of the government's debt! Unlikely, but not impossible.

Yes the Bank of England will write off the bonds if it has to.

And yes that will happen to a big chunk of the government debt, which is why teh situation is considerably less bad than it is made out to be.