Ahead of the curve
Say what you like about the Bank of England, in launching its first £2bn purchase of government bonds today it is definitely ahead of the curve.
Even the US Federal Reserve, which has been several steps ahead of our central bank for most of this crisis, has yet to press the button on this form of QE.
The Fed has been buying up corporate bonds for several months, but the Chairman, Ben Bernanke has so far resisted calls to buy US government debt. Does he know something that Mervyn King doesn't?
When asked, Ben Bernanke says he has no ideological objection to buying government debt - he simply thinks that right now, it's more effective to tackle the corporate credit shortage directly.
There are several reasons the Bank can't follow his lead. One is simply that the US corporate bond market is much, much bigger relative to the size of the economy than ours is.
If the Bank of England tried to buy £75bn-worth of corporate bonds it would find itself buying up roughly the entire market. It would then be in the uncomfortable position of being the sole purchaser of the debt of some of Britain's biggest companies. (Incidentally, the pool of corporate assets to buy would expand greatly if they could buy up syndicated loans as well. They may do that some time in the future but that's not on the cards right now.)
Our central bank is also concerned about taking too much corporate risk onto its balance sheet. That doesn't seem to be much of a worry to the Fed (though some at Threadneedle Street wonder why not).
As I mentioned last week, the danger in taking on too much private sector risk is that you push up the risk premium on government debt, raising borrowing rates for everyone and defeating the whole exercise.
Of course there is the opposite risk, which you might call the price of QE's success. What if the policy succeeds - the economy recovers, interest rates go up, bond prices fall and the Bank ends up selling these assets back at a loss?
In a sense, that is an inherent part of the policy. It would certainly come as no surprise to Bank officials. That is why the Bank of England had to obtain an indemnity from the Treasury to make these purchases through a special subsidiary - the Asset Purchase Facility.
Any paper loss on these assets when they are sold back to the market will have to be made good by the Treasury, so there isn't a hole in the Bank of England's accounts. But it's part of the oddity of QE that the loss to the taxpayer, in this case, will also be the taxpayer's gain. For who will have benefited more from the initial fall in gilt yields than the government itself?
Think about it. For the next three months, the Bank of England's going to be buying up more medium-term gilts than the government is issuing. For decency's sake, the Bank has to wait until the debt has been on the market for all of a week, but the effect is the same.
If those purchases push up the price of gilts, that will make it cheaper for the government to borrow during this period than it would otherwise have been. That means the debt will cost us taxpayers less.
If and when gilt prices fall again, the Bank of England may have to sell them at a loss. But that loss is the mirror image of the earlier gain. You never know, we might even come out ahead. And we'd no longer be in a recession. It's a little Alice in Wonderland perhaps, but that's the nature of QE.