After the global financial crisis, normal attempts to stimulate economic recovery fell flat. Standard ‘transmission methods’ (processes that affect money), did not do enough to stimulate the economy.
As a result, many countries' central banks introduced quantitative easing (QE) as an alternative strategy. Many saw using QE as an unconventional tactic, and the move was not without controversy. The Bank of England began its QE programme in 2009.
Professor Ian Tonks worked with the Bank of England to look at UK investment behaviour. His analysis showed it was consistent with QE theory, and that this likely helped stimulate the economy.
How quantitative easing can boost growth
Quantitative easing inflates the financial system by creating new money. Central banks then use these funds to buy assets (such as government bonds) from financial institutions, like commercial banks.
This increases the amount of usable money in the economy. With more available, financial institutions are more likely to lend.
This raises stock prices and lowers interest rates, boosts investment and (in theory) helps economic growth all round.
It’s believed that thanks to QE, interest rates on things like mortgages and corporate debt are now lower than they would be otherwise.
How quantitative easing affected UK investor behaviour
Ian’s work focused on the behaviour of UK-based insurance companies and pension funds after the Bank of England introduced QE. Specifically, it looked at how these institutions chose to invest this ‘new’ money.
To do this, Ian and colleagues analysed a range of data sources to see whether institutions’ investment behaviour changed in line with financial leaders’ expectations.
The findings suggested that:
- less was invested in government bonds than would have been without QE
- more was invested in riskier corporate bonds
Impact and Influence
Ian’s analysis showed that insurance companies and pension funds were more inclined to use new funds to invest in corporate bonds. These are riskier than government bonds, but have a higher rate of return.
This shift from lower to higher risk assets is known as the ‘portfolio balance channel’. Financial policymakers emphasise how vital this is to making QE programmes work.
When European Central Bank (ECB) President Mario Draghi wanted to justify increasing the ECB QE programme, worth €1.1 trillion, he turned to Ian’s work.
Speaking in Frankfurt in March 2015, he said:
Model-based estimates show that as a consequence of the Bank of England’s quantitative easing programme, insurance companies and pension funds invested less in gilts [government bonds] and more in corporate bonds leading to price increases of both investment grade and non-investment grade corporate bonds.
Ian’s work gave policy-makes confidence that QE would work. The success of this policy shielded the rest of Europe from contagion effects of the Greek crisis and helped stimulate European growth and contributed to a fall in unemployment.