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

My concern will be that Quantitative easing could cause massive inflation over the long term which to combat could result in higher interest rates being introduced.

I felt the interest rate reduction of half a per cent was a complete waste of time. This policy has not worked and instead it has punished savers 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 I would like to see support from all parties to ensure the economy is turned around as quick as possible.

To hear Mike comment on this on BBC Wales then click here - then look under 5 Mar 2009.