Bank of England, Bank of England
How does your QE grow?
By silver debasement and reserve placement,
And uncertainty set out below.*
Monetary Policy Committee member David Miles gave a speech on Thursday about the Bank of England’s asset-purchasing programme; quantitative easing (QE).
In addition to an absorbing Locke vs Lowndes tale about silver coinage in 17th century Britain, it has some very interesting comments on the purpose and efficacy of the extraordinary policy measure.
First, here’s how Miles defines the QE process:
The Bank’s purchases under the APF – QE – are financed through the creation of reserves. The type of assets that the Bank has bought were very largely held outside the banking sector. Those outside the banking sector who have sold assets, which have largely been gilts, will initially deposit the proceeds of their sales with banks. So sterling bank deposits are likely to initially rise by an amount comparable to the Bank of England’s purchases from non-banks. Much of that money – which will be part of broad money – may not stay put for long. The initial sale of gilts will trigger further portfolio re-balancing. In most cases, the extra money created does not disappear through this process of portfolio rebalancing. Instead the extra money is passed around the economy – from investor to investor.
The idea is that by pushing additional reserves into the system, QE can encourage banks to use the cash to buy other assets. The other big aim of QE, which now seems to be losing favour among MPC members, is that it was also meant to encourage banks to lend. Financial institutions would need to re-establish their target balance sheet ratios, and would extend loans to do it.
So when it comes to the current effects of QE, Miles says:
Many of those who have sold gilts will seek assets that are closer substitutes for them than are bank deposits. Corporate bonds, equities and property have longer duration than cash and so for many might be more natural alternatives to gilts than money in a bank deposit. But those assets are not perfect substitutes – they have different risk and liquidity characteristics. Any portfolio re-balancing will tend to increase demand for assets that are substitutes for gilts and because they are not in perfectly elastic supply their prices will – all else equal – move up. That might encourage greater private sector issuance of bonds and equities. The proceeds of any new issuance could be used directly to finance spending. If the money is used to reduce leverage and cut bank debt, it would then not show up in a measure of the money supply, but that is still likely to have beneficial effects.
. . .
How all this evolves – and where the money ends up – can play out in different ways. The effects are a bit like those from pumping water into a dry area: it is hard to know which channels the water will flow down, and much of it will seem to disappear, but that does not mean we are clueless on the nature of its impact. Most of the channels through which the money might be flowing are helpful in alleviating the problems in the financial sector, and with banks in particular, where confidence had been shattered. One can be unsure which are the most important channels. I know I am. But most of them are helpful and it seems to me that none, in the current environment, are obviously harmful.
Perhaps unsurprisingly Miles doesn’t think the QE policy is particularly inflationary, and he argues that without it, broad money would have fallen by around 5 per cent by the end of 2009.
Instead it increased by over 1 per cent.
Full speech available here.
*With apologies to school children everywhere.
Related links:
US Housing Bubble v2.0 – FT Alphaville
Moving targets, QE edition – FT Alphaville
Allocating, multiplying QE – FT Alphaville