The Bank of England's Monetary Policy Committee today voted to keep interest rates at 0.5%.

The Committee also voted to increase its programme of asset purchases, often referred to as quantitative easing, by injecting over a period of time another £50 billion, this will make the total of £175 billion to be injected into the economy by central bank reserves.

Quantitative Easing explained

By reducing interest rates, the Bank of England has been trying to raise the amount of lending and increase activity in the economy indirectly because lower interest rates tend to encourage people to spend more and not save.

Individuals, particularly those with tracker mortgages, end up spending less each month on their repayments which releases more disposable income to spend which in turn helps the economy.

However if this doesn't have the desired effect and interest rates can go no lower, an option is for Central banks, such as the Bank of England, to pump more money into the economy by a process known as quantitative easing.

This is where Central Banks buy up assets such as government and corporate bonds held by the commercial banks thereby injecting money back into banking world. The theory is that by flooding the financial system with money in this way, the increase in the banks' money supply will lead to an increase in confidence, an increased volume of lending and a stimulation of growth.

It is believed that by easing the pressure on banks they will have extra capital and with interest rates now as low as they are likely to go, quantitative easing should hopefully force down longer term rates, which are the rates that companies and individuals borrow at, as well.

How do we know if it has worked?

The first indications will be an upturn in credit growth and businesses will find it easier to get credit. This should then help stimulate the economy and help push inflation levels back to the Bank of England's target figure of 2%, thus staving off the threat of deflation.

How long could it take?

No one knows, not even Mervyn King, the Governor of the Bank of England.

Has it ever worked before?

No.

DebtWizard Comment

Quantitative easing could cause inflation over the long term which to combat could result in higher interest rates having to be introduced. The amount the government is to put into the economy under this scheme has gone up from 125 billion to 175 billion.

There is a risk of doing too little instead of too much in what is seen as a very fragile economy, so perhaps this has to be welcome as no one really knows when the effect of quantative easing will be truly felt. 

Some analysts argue that the historic low interest rate of half a per cent has not helped the economy with many savers feeling  they are being punished for being prudent with their money.

We can all be arm chair economists and easily criticise after the event. I believe the Government will do their best to get the economy going and we need support from all parties to ensure the economy is turned around as quick as possible.