Quantitative Easing was supposed to be a temporary tool used to stabilize the UK economy in the aftermath of the 2008 Global Financial Crisis. The policy worked, but had several negative unintended consequences included asset inflation and distortions in the housing market. Tami Oren and Ronen Mandelkern expose how a temporary policy can become a permanent fixture, even when it becomes counterproductive.
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In the aftermath of the 2008 Global Financial Crisis, governments and central banks implemented unconventional policies to stabilize their economies. The UK, as a global financial hub, adopted Quantitative Easing (QE) as a central intervention, initially intended to be a temporary measure. However, what was expected to provide short-term relief has transformed into a long-term feature of the UK’s economic policy landscape. So the question is, what are the mechanisms that transformed temporary interventions like QE into enduring counterproductive policies.
Over time, temporary measures become difficult to reverse and are retained as permanent policy features, even when they have counterproductive effects.
Mechanisms of counterproductive evolution
We employ a theoretical framework according to which a) policymaking is mediated by prevailing ideas and institutions and b) policy outcomes might evolve recurrently in counterproductive ways, thereby generating unintended changes in the ideas and institutions which have guided them in the first place. We call this approach a constructivist-evolutionary theory of institutional change. In the case we explore here, short-term interventions are initially adopted in response to a crisis, but when these interventions produce unintended outcomes or fail to meet expectations, they generate new rounds of policy adaptation. Over time, temporary measures become difficult to reverse and are retained as permanent policy features, even when they have counterproductive effects.
In the UK, this mechanism became evident when QE, an unconventional measure originally intended to counteract deflationary pressures and shore up growth managed to decrease inflationary pressures but also resulted in unintended consequences such as asset inflation and distortions in the housing market. These results triggered further rounds of QE, which eventually became embedded in the UK’s macroeconomic policy toolkit, but also forced the employment of varied monetary policy and housing market interventions. This process reflects the “counterproductive evolution” where policies initially intended as temporary solutions unintendedly evolve into lasting constraints on economic governance forcing both institutional change and the employment of different types of policy interventions.
Instead of stimulating lending to the real economy QE primarily drove up financial asset prices – namely securities and property prices.
QE as the catalyst for policy evolution
The first round of QE implemented by the Bank of England in 2009, injecting £200 billion into the financial system, was designed as a short-term measure to address deflationary pressures. However, the interaction between macroeconomic ideas and policy experimentation is crucial. Macroeconomic ideas, such as the idea that keeping inflation on specific level in order to secure price stability must be the primary goal of macroeconomic policy, commonly known as inflation targeting, initially constrained policy solutions to measures like QE, viewed as temporary and necessary to restore stability. Yet, as the gap between expectations and outcomes widened, space opened up for policy variation.
Instead of stimulating lending to the real economy – which includes non-financial business activity and households consumption – QE primarily drove up financial asset prices – namely securities and property prices – as it operated through the purchasing of financial assets. At the same time, QE failed to generate sufficient lending to households and businesses. These unintended outcomes did not lead to an immediate abandonment or reassessment of QE’s effectiveness. Rather, constrained by existing macroeconomic ideas, policymakers expanded QE, pushing its total volume to £375 billion by 2011. This expansion occurred not due to a re-evaluation of QE’s results but as an outcome of macroeconomic ideas limiting the space for alternatives, while simultaneously being reshaped by the failure of initial rounds of QE.
As QE reduced interest rates and increased liquidity, it unintentionally inflated asset prices, including property values.
The impact on the housing market
One of the key mechanisms in the counterproductive evolution of UK policy was the transmission of QE’s effects into interconnected markets, especially the housing sector. As QE reduced interest rates and increased liquidity, it unintentionally inflated asset prices, including property values. Investors seeking higher returns channelled capital into property markets, driving up house prices and exacerbating affordability issues.
To counter the credit stagnation caused by the financial crisis and the widening housing market distortions, the government introduced the Funding for Lending Scheme in 2012, followed by the Help to Buy scheme in 2013. Both measures were designed to encourage lending to households, particularly first-time buyers, but like QE, they produced mixed results. Help to Buy, instead of solving housing affordability problems, led to further price inflation, benefiting wealthier buyers while making it harder for others to access the market. This represents another layer of counterproductive evolution, where interventions meant to address market issues unintentionally reinforce the very problems they were designed to solve.
The shifting role of the state
The vertical transmission of policy ideas, another key mechanism, refers to how short-term interventions influence broader macroeconomic priorities over time. Initially, unconventional policies like QE were justified under the traditional framework of inflation targeting. However, as the interventions became more entrenched, they began to reshape the broader macroeconomic framework itself.
The UK’s experience shows how short-term economic interventions, particularly QE, led to a counterproductive evolution in policymaking.
A significant example of this was the adoption of Flexible Inflation Targeting by the Bank of England in 2013. Under this scheme the Bank of England reinterpreted its primary focus on keeping inflation under control, to allow for the prioritization of economic growth in the short term. This marked a departure from the pre-Global Financial Crisis orthodoxy of inflation control and allowed for further rounds of QE and other unconventional measures. This evolution exemplifies how short-term interventions gradually modify the prevailing macroeconomic ideas, embedding new tools and approaches into the conventional policy toolkit.
The UK’s experience shows how short-term economic interventions, particularly QE, led to a counterproductive evolution in policymaking. The expansion of QE, the horizontal spill-over effects into the housing market, and the vertical shift in macroeconomic priorities demonstrate how the interaction between policy experimentation and evolving macroeconomic ideas can transform short-term measures into long-term policy features.
All articles posted on this blog give the views of the author(s), and not the position of LSE British Politics and Policy, nor of the London School of Economics and Political Science.
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