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The Bank of England this week announced its fourth interest rate cut in succession, bringing the base rate down to 1.5% - a record low. But many analysts believe these cuts are unlikely to succeed in their aim of reviving economic growth - so is the only way out of the mess to print and dish out wheelbarrow loads of new money? Our Special Correspondent Nic Cicutti investigates

For keen students of new economic terms, here’s a fresh one to get your teeth stuck into - “Zirp”.

No, this has nothing to do with science fiction. Zirp stands for “zero interest rate policy”, a mechanism for encouraging investment within the economy by making capital purchases more financially attractive. You do this by cutting interest rates to zero, making it easier to spend and borrow than to save and pay off debt.

The UK this week edged closer to Zirp territory this week, after the Bank of England announced a further cut in its base rate, down to just 1.5%. Most experts agree that in the next few months further cuts are likely, bringing the UK in line with rates in the US, where they stand at between 0.25% and zero.

Will the rate cuts work?
The key question is whether this strategy of cutting interest rates to revive the economy can work. More and more economists say it can’t, or at least not on its own.

Evidence suggests that instead of spending more, most people are trying desperately hard to pay down as much of their mortgages and other credit bills as they can. Meanwhile, many elderly savers are finding their small nest-eggs are paying them less and less income, forcing them to cut their own spending.

To succeed, it is now being argued, we need another - more radical - strategy, which is now being dubbed “quantitative easing”.

Quantitative easing: A licence to print money?

Quantitative easing was once described as the “helicopter strategy”, after the current US Federal Reserve’s chairman Ben Bernanke colourfully described this policy - before his eventual appointment - as dropping dollar bills from a helicopter onto the population below.

More seriously, the aim of quantitative easing is to boost the money supply. The theory is that if the normal process of cutting interest rates isn’t working - and rates are so low that it’s impossible to cut them further - you try to get money flowing around by other means.

The way you do it is by a central bank, the Bank of England over here or the Fed in the US,   buying assets in exchange for money. In theory, any assets can be bought from anybody. In practice, the focus of quantitative easing is on buying securities (like government debt, mortgage-backed securities or even equities) from banks. By doing this, you are increasing the “quantity” of money in the economy.

Where does all the money come from?
In practice you don’t actually need to print out brand new fivers and tenners. There are more sophisticated ways to boost a nation’s money supply - but ultimately the impact is not very different from the helicopter approach.

What the Bank of England can do is simply increase the size of commercial banks’ own accounts - otherwise known as “reserves” - at the central bank itself. All banks have to hold some reserves at the central bank. But when the Bank of England buys their assets, they end up with “excess reserves”, effectively too much money in their accounts.

If that happens, their own balance sheet shrinks while that of the Bank of England grows. So assuming they want to make their money work for them they will then start lending to borrowers, thereby pumping cash into the economy.

That’s the theory, anyway. In practice, it isn’t certain that banks with too much liquidity will necessarily want to lend it out again right now.

Could quantative easing actually work?

It’s hard to say if a policy of quantative easing will actually work. The US strategy hasn’t worked so far - despite the vast cash injections seen in recent months, credit has not become easier to obtain over there. On the other hand, some people argue that in order for this approach to work properly you have to throw the kitchen sink at it.

In Japan, for instance, where the government tried is own version of quantitative easing between 2001 and 2006, commercial banks over there ended up increasing their “reserves” seven-fold with the Bank of Japan.

Yet economic growth was fairly subdued and as soon as money stopped being spent, the economy stopped growing. The argument is that the Japanese tried this strategy, but did so too late in terms of the nation’s economic cycle and pumped too little money in.

Is there a downside to all of this?
As ever, there is. It could theoretically lead to a combination of sterling collapsing and inflation running rampant again.

In the past, attempts to print your way out of trouble by simply keeping the money presses rolling have led to desperate economic crises - look to Germany in the 1920s and present-day Zimbabwe to see what can happen.

To be sure, neither the UK or US are similar economic basket cases but there still is a – admittedly very remote - danger of this happening here too. And if it did, would the Bank of England be able to recognise the symptoms quickly enough and react accordingly?

They would need to engage in a reverse of their previous strategy and this time engage in “ quantitative tightening”. Sadly, the omens are not good: the Bank of England failed to predict the potential impact of the current crisis, thereby making it infinitely more difficult to solve.

They had better get it right this time: there really is no other bright idea to get us out of this mess.

Article Courtesy of Nic Cicutti @ The Money Sky