Getting quantitative easing right

The Bank of England is about to announce quantitative measures. The crucial thing to watch for is not the type of asset that the Bank will purchase, whether it will be private sector assets, for example corporate bonds, or public sector ones, for example gilts. Who is selling the asset is much more important. The Bank has so far failed to make a clear distinction and most of the media have got it wrong. 

Buying assets from banks merely involves a change in the composition of banks’ assets, exchanging company and government bonds for balances with the Bank; that is, it increases banks’ reserves but not bank deposits. If the assets are purchased from non-banks the sellers receive bank deposits in exchange for their assets and the amount of money in the economy is increased directly. The distinction is very important because the lesson from the 1930s in the US and the last decade in Japan is that in a deep recession boosting bank reserves will not work if monetary growth remains inadequate. 

Update 16:25 - The Bank’s News Release just issued (on 5 March) states, “the Bank would also buy medium- and long-maturity conventional gilts in the secondary market”. Such gilts are unlikely to be held by banks because they are too long-dated. The purchases will therefore boost monetary growth providing the seller is a UK resident (if the seller is non-resident, non-resident bank deposits will rise but these are excluded from the definition of the money supply).

Gordon Pepper is the author of Reflections on Monetary Policy: Then and Now.

If the BoE just ‘buys’ gilts, then this is one branch of government swapping bits of paper with another. If holders of gilts really wanted cash, they would simply sell them on the open market.Therefore, it only makes a difference if BoE ‘buys corporate bonds from banks’ AND they buy them at above market value – by definition, if banks preferred cash to corporate bonds, they can just sell them on the open market.But ‘buying corporate bonds’ is much the same as ‘lending businesses money’ (or bailing out bondholders). So it only makes a difference to the businesses affected if they can borrow more cheaply from the government/BoE than from commercial banks.Either way, taxpayer doomed.

You write if holders of gilts want cash they would simply sell them on the open market. To whom? If they are sold to someone else in the non-bank private sector the buyer’s cash falls and there is no change in the amount of money in the economy. Analysis of the system as a whole is very different from analysis of components,see my book ‘The Liquidity Theory of Asset Prices’, Wiley, 2006.

If the BoE just ‘buys’ gilts, then this is one branch of government swapping bits of paper with another. If holders of gilts really wanted cash, they would simply sell them on the open market.Therefore, it only makes a difference if BoE ‘buys corporate bonds from banks’ AND they buy them at above market value – by definition, if banks preferred cash to corporate bonds, they can just sell them on the open market.But ‘buying corporate bonds’ is much the same as ‘lending businesses money’ (or bailing out bondholders). So it only makes a difference to the businesses affected if they can borrow more cheaply from the government/BoE than from commercial banks.Either way, taxpayer doomed.

You write if holders of gilts want cash they would simply sell them on the open market. To whom? If they are sold to someone else in the non-bank private sector the buyer’s cash falls and there is no change in the amount of money in the economy. Analysis of the system as a whole is very different from analysis of components,see my book ‘The Liquidity Theory of Asset Prices’, Wiley, 2006.

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