Investment special: The zero era

The Bank of England’s latest announcement of quantitative easing, widely referred to as QE2, prompts as many questions as it does answers — particularly for investors and pension-holders. Under a QE regime, money printed out of thin air is used to purchase government bonds from banks and other private sector investors. The theory then has it that long-term interest rates will fall, and banks will have more money to lend to eager borrowers.

There’s just one problem with this cunning plan: it doesn’t work. It did not work in Japan, the first country to flirt with QE. Richard Koo, chief economist of the Nomura Research Institute, calls QE ‘the 21st century’s greatest monetary non-event’. The reason for his scepticism is that we are not in a normal business-cycle recession, in which the central bank reacts to a disorderly economic boom by hiking interest rates to suppress inflation. Businesses retrench, and as inflationary pressure subsides, interest rates are gradually reduced.