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ange or also known as quantity theory of money shows the relation between aggregate demand, money and GDP. According to the theory, MV = PT. Where M is the money in the economy, V is the speed with which money flows around the economy. P is the price level and T is the GDP or value of transactions. Quantitative easing aims to increase the T i.e. the number of transaction in the system by increasing the money. It also implies that if inflation has to be controlled it should be done by controlling money supply (John Solman, p 630)

 

If injection of money is not equal to withdrawals, disequilibrium will exists. Equilibrium can be regained by change in GDP. Over many years, Keynesian model was used to explain the monetary policy. Keynesian model arguedthat GDP is determined by aggregate demand and governments should manage the level of aggregate demand to avoid recession. (John Solman, p626). However this model will work through influencing expectation (Eggertsson and Woodford ,2003).Expectation played an important role in quantitative easing policy. If people believe that money supply will cure inflation then their will increase investment and if they think otherwise then it will lead to liquidity trap – i.e. injecting money is not equal to withdrawal. (johnSolman, p649)

 

QUANTITATIVE EASING BY BANK OF ENGLAND

 

Economic slowdown has restricted lending and reduced demand and output felled. Main Challenge was to bring aggregate demand and supply to normal. The Bank of England aims to maintain a stable inflation rate of 2%, set by Government. Banks cut the interest rate during slowdown to boost the consumer spending and to reduce the risk of inflation falling beyond the target (bankofEngland.co.uk, 2009). Bank of England has cut the bank rate from start of October 2008 to 0.5% in March 2009. (Michael Joyce et al, 2010). Interest rate of 0.5% is lowest in banks of England’s 305 years of history (bbc.com, 2010). But cutting the interest rate didn’t ease the credit crunch. To ease the monetary situation further, Bank of England began a programme of asset purchasing known as quantitative easing in March 2009 with the aim of injecting money in to the economy and meeting the inflation target (Michael Joyce et al, 2010). Most of the assets purchased are government bond gilts [2] and other asset purchased was corporate bond. These purchases have expanded the Bank’s balance sheet as a proportion of nominal GDP to three times its level before i.e. nearly to 15% GDP.

 

Bank of England purchased 200,000 million pounds of assets by Feb. 2010. This policy expands the central bank’s balance sheet in order to increase the money in the economy (Bernanke and Reinhart, 2004).

 

With this policy, Bank of England has objectives:

 

Quantitative easing will reduce the cost of capital on households and businesses

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