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Is quantitative easing really just printing money?

Stephanie Flanders | 12:59 GMT, Wednesday, 18 February 2009

And the sound you heard was the sound of a printing press being warmed up.

Bank of EnglandThe release of the minutes from the February meeting of the MPC confirms that the committee which sets UK monetary policy wants their power to go beyond interest rate cuts, with direct purchases of assets by the central bank, also known as quantitative easing (QE).

The big questions are: what happens next? Is it really printing money? And, finally, will it work? The first two are easier than the last.

What happens next (if it hasn't happened already) is that Mervyn King will write a nice letter to the Chancellor asking "please can we use the Asset Purchase Facility (APF) to buy a range of securities on the Bank's own account, using money we've created for ourselves?" We can be fairly confident that Alistair Darling will say yes.

At the MPC's next meeting, there may then be two votes - one on the level of Bank rate (base rates), and one on the level of any Bank-financed purchases through the APF. If it doesn't happen in March it will surely happen soon.

If they decide to go ahead with QE, that will be a change of policy, and we can expect a statement recording that fact. But unlike a change of Bank rate, QE is an ongoing process not an event. So the MPC may vote to authorise purchases over an extended period rather than month to month.

Traditional "QE" involves buying just government securities, or gilts. However, the minutes indicate that the MPC will be looking to buy high quality corporate securities as well, just as the Bank bought commercial paper on the government's behalf last Friday (the first official use of the APF).

If and when we go to QE (and it surely is now a matter of when), I think we can expect significant purchases of both gilts and commercial securities.

Large scale central bank purchases of government debt make people nervous, for reasons I'll get to in a minute.

But purchases on the £50bn-plus scale we're probably talking about would quite simply swamp the corporate debt market. There isn't enough to go around.

You'd also be taking a lot of higher risk assets on to the public balance sheet (via the Bank), which could raise the risk premium on government debt and send long-term interest rates in precisely the wrong direction.

So, we can expect the Bank to buy a lot of gilts as part of this policy. Is that "printing money"? The politicians will say no. But any economist would say yes.

A few weeks ago I discussed one definition of printing money, which was a deliberate expansion of the central bank's balance sheet and the monetary base (the narrowest measure of the money supply). Ben Bernanke, among others, has associated himself with this definition.

But the most popular definition of printing money - the one the politicians are terrified of - is simply central bank financing of government deficits. Also known as "monetizing the government debt".

Since the Bank will be purchasing gilts on the secondary market, not from the government directly, the government will almost certainly say that this is not monetizing the debt. To say otherwise conjures up vision of Weimar and Zimbabwe.

To preserve this distinction, the Bank of Japan was legally forbidden to buy debt directly from the Ministry of Finance when they undertook QE in the 1990s.

Funnily enough, the Bank of England faces the same legal constraint: Article 101 of the Maastricht Treaty (of all things) forbids direct central bank financing of deficits.

But it is a distinction without a difference. When the Bank of England buys up gilts, one arm of the government is buying up debt owed by another arm of the government in exchange for money created by the central bank. Whether the gilt is brand new, or issued the day before, is quite simply irrelevant.

That said, there are big practical differences between this policy and Zimbabwe-style money financing. The most important is that the Bank is choosing to buy gilts as a means to an end. It is not being forced to buy them because the government has nowhere else to go.

Also - and crucially - the Bank has every intention of unmonetizing the debt when the storm is past. In other words, it's going to sell it all back.

So in that sense, QE will not directly affect the stock of government debt one way or another. (Certainly there won't be any direct change to the amount of debt on the Treasury's books.)

It may even make the debt management office's job harder, by putting a lot of extra gilts back into the market, at a time when issuance of new debt is still running high.

But if QE works, the government will clearly benefit from a faster upturn in the economy - and so will all of us. I will tackle that thorny question in a later post.


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