Back in March the Bank of England thought they would tell us about quantitative easing. It went like this:
Quantitative Easing Explained
In March 2009, the Monetary Policy Committee announced that, in addition to setting Bank Rate at 0.5%, it would start to inject money directly into the economy in order to meet the inflation target. The instrument of monetary policy shifted towards the quantity of money provided rather than its price (Bank Rate). But the objective of policy is unchanged – to meet the inflation target of 2 per cent on the CPI measure of consumer prices. Influencing the quantity of money directly is essentially a different means of reaching the same end.
Significant reductions in Bank Rate have provided a large stimulus to the economy but as Bank Rate approaches zero, further reductions are likely to be less effective in terms of the impact on market interest rates, demand and inflation. And interest rates cannot be less than zero. The MPC therefore needs to provide further stimulus to support demand in the wider economy. If spending on goods and services is too low, inflation will fall below its target.
The MPC boosts the supply of money by purchasing assets like Government and corporate bonds – a policy often known as 'Quantitative Easing'. Instead of lowering Bank Rate to increase the amount of money in the economy, the Bank supplies extra money directly. This does not involve printing more banknotes. Instead the Bank pays for these assets by creating money electronically and crediting the accounts of the companies it bought the assets from. This extra money supports more spending in the economy to bring future inflation back to the target.
Assessing the Impact of Asset Purchases
It will take time to assess the extent to which the MPC's asset purchases have stimulated nominal spending. The impact is inevitably uncertain, but over time increasing the amount of money in the economy should boost spending. The MPC is monitoring the situation closely to assess how firms and households respond to the extra money injected into the economy. It will pay close attention to the growth rate of broad money, the cost and availability of corporate borrowing, measures of inflation and inflation expectations, and developments in nominal spending growth.
They even printed a booklet
Quantitative Easing Explained Pamphlet
Download PDF (1Mb)
Did that make sense? The Bank of England was going to buy lots of gilts off the banks which would make them flush with cash so they would spend it. Read the pamphlet and it tels you that buying up gilts pushes up the price of gilts so the banks make a profit on their holding of gilts which bolsters their tier 1 equity and makes them full of cash.
Well not quite because in a new speech, Charlie Bean says forget about the bit about making the banks flush with cash. No that isn't the point at all. The idea is to boost the value of gilts, forget about the idea of filling the banks with cash equivalent reserves, apparently that was not the point at all, even though that was what they said in March.
Now this is where it gets interesting because Mr Bean was addressing the London Society of Chartered Accountants, who understand a thing or two about bookkeeping but wouldn't necessarily have a clue about markets, so no tricky questions on that from them. But what Mr Bean did tell them was that the Asset Purchase scheme is booked off the balance sheet of the Bank of England, because all the risk in the structure is taken by the government.
So if the QE programme isn't on the Bank's books, where does it go. With the government's accounts in theory. In practice the government auditors will probably let the balance sheet just float off into space, just like National Rail and a whole lot more, but any analyst would say the government now holds £175 billion of its own paper (which can be netted against the liability), but it also has a £175 billion liability for the deposits created at the Bank of England. So in net asset terms nothing has changed for the government.
On the other hand, maybe it has affected the market price of gilts by taking £175 billion out of the market? Well if that really did have an effect, we would expect the opposite effect from the £175 billion of additional gilts issued into the market to fund the deficit. And so it turns out. As Chart 2 shows at the back of Mr Bean's speech, yields in October 2009 for the 3,5,10 & 20 year gilts are about the same as the yields in January 2009. In other words, no change in yield and thus no change in the value of securities held by the banks.
So that was a £175 billion waste of time.